1. Alabama Bank is willing to buy or sell British pounds for $1.98. The bank is willing to buy or sell Mexican pesos at an exchange rate of 10 pesos per dollar. The bank is willing to purchase British pounds at an exchange rate of 1 peso = .05 British pounds. Show how you can make a profit from triangular arbitrage and what your profit would be if you had $100,000.
2. You go to a bank and are given these quotes:
• You can buy a euro for 14 pesos.
• The bank will pay you 13 pesos for a euro.
• You can buy a U.S. dollar for .9 euros.
• The bank will pay you .8 Euros for a U.S. dollar.
• You can buy a U.S. dollar for 10 pesos.
• The bank will pay you 9 pesos for a U.S. dollar.
• You have $1,000. Can you use triangular arbitrage to generate a profit? If so, explain the order of the transactions that you would execute, and the profit that you would earn. If you cannot earn a profit from triangular arbitrage, explain why.
3. Interest rate parity exists between the U.S. and Poland (its currency is the zloty). The one-year risk-free CD (deposit) rate in the U.S. is 7%. The one-year risk-free CD rate in Poland is 5% and denominated in zloty. Assume that there is zero probability of any financial or political problem in either country such as a bank default or government restrictions on bank deposits or currencies. Myron is from Poland and plans to invest in the U.S. What is Myron's return if he invests in the U.S. and covers the risk of his investment with a forward contract?
4. Assume the following information:
Quoted Price
Spot rate of Canadian dollar $.80
90 day forward rate of Canadian dollar $.79
90 day Canadian interest rate 4%
90 day U.S. interest rate 2.5%
• What would be the yield to a U.S. investor who used covered interest arbitrage? What market forces would occur to eliminate any further possibilities of covered interest arbitrage?
5. The current spot exchange rate is Y190/$ and the 1-year forward rate is Y210/$. The prime rate in the US is 15 percent.
a. What should the Japanese prime rate be?
b. According to the forward parity, by how much should the dollar change in value during the next year?