I. Triangular Currency Arbitrage.
Assuming no transaction cost, suppose $1.5271 / £ in NY, $0.9250 / € in Frankfurt, and €1.6645 / £ in London. Can you find any arbitrage profit opportunity? Show how you get the arbitrage profit.
1) Identify if there exists a triangular arbitrage opportunity.
2) What is your strategy to achieve your profit?
3) How much is your triangular arbitrage profit?
Start with $1,000,000.
II. Covered Interest Arbitrage. Assume the following information:
Spot rate of Mexican peso = $ .100
Forward rate of Mexican peso = $ .098
Mexican interest rate = 8%
US. interest rate =5%
1) Show how to identify any arbitrage opportunity based on the Interest Rate Parity (IRP).
2) What is your strategy to achieve your profit?
3) What is your arbitrage profit per $1,000,000?
III. Purchasing Power Parity (PPP).
1. Given the following information for the year 1980 and 1995,
1980 1995 i (80-95)
Japanese ¥ $0.0044 $0.0107
CPI (Japan) 91.0 120.0
CPI (US) 82.0 152.0
calculate 1) inflation rates for US and Japan over the entire period, and 2) the PPP-predicted ER (Japanese ¥) in 1995. What can you say about the change in Japanese ¥ during the period (over-appreciate or under-appreciated)?
2. What would the impact of this ¥ change on Japanese economy? What were the Japanese firms' strategy?
IV. Fisher Effect (FE) and International Fisher Effect (IFE).
1. Given the following information US and UK inflation and interest rates
Inflation Rate ST interest rate
US 5% 6%
UK 4% 4%
where will investors (arbitragers) move their capital based on the Fisher Effect? And why?
2. Suppose ER(£) = $0.6750/£. What is your expected ER(£) based on the Int'l Fisher Effect?
V. Interest Rate Parity. Suppose that the interest rates (annual) in Japan and US are 6% and 8%, respectively. If the spot rate is ¥142:$1 ($0.007042/¥) and the 90-day forward rate is ¥139:$1 ($0.007194).
1. Is there any arbitrage opportunity based on the Interest Rate Parity (IRP)? Where would you borrow and where would you invest?
2. What would be your arbitrage profit per $1,000,000 based on IRP?