--%>
Assignment Help - homework help

Magnitude of arbitrage profit and covered arbitrage process

Assume that the current spot exchange rate is FF6.25/$ & three-month forward exchange rate is FF6.28/$. In the U.S. the interest rate of three-month is 5.6% per annum and 8.8% per annum in France. Suppose that you can borrow up to $1,000,000 or FF6,250,000.

a. Estimate how to realize a definite profit by means of covered interest arbitrage, considering that you desire to realize profit in terms of U.S. dollars. Estimate the magnitude of arbitrage profit.

b. Suppose that you desire to realize profit in terms of French francs. Illustrates the covered arbitrage procedure and find out the arbitrage profit in French francs.

The market data is concise as:

   S = FF6.25/$ = $0.16/FF; 

   F = FF6.28/$ = $0.1592/FF; 

   I$ = 1.40%;   iFF = 2.20%

   (1+I­) = 1.014 <  (1+iFF)(F/S) = (1.022)(.1592/.16) = 1.0169 

a. (1) Borrow $1,000,000; repayment $1,014,000.

    (2) Buy FF6, 250,000 spot for $1,000,000.

    (3) Invest in France; maturity value is FF6, 387,500.

    (4) Sell FF6, 387,500 forward for $1,017,118.

    Arbitrage profit $3,118 = $1,017,118 - $1,014,000.

b. (1) Borrow $1,000,000; repayment $1,014,000

    (2) Buy FF6, 250,000 spot for $1,000,000.

    (3) Invest in France; maturity value FF6, 387,500.

    (4) Buy $1,014,000 forward for FF6, 367,920.

    Arbitrage profit will be FF19, 580 = FF6, 387,500-FF6, 367,920.

 

   Related Questions in Financial Management

  • Q : Dimensions of income statement what are

    what are the time dimensions of time income statement, the balance sheet, and the statement of cash flow?

    		•
  • Q : Explain the denotation a utility

    Explain the denotation a utility function and how it can vary between investors?

    		•
  • Q : Internal rate of return Which is the

    Which is the deciding factor for rejecting or accepting proposed projects while using internal rate of return?

    		•
  • Q : What is a Poisson Process What is a

    What is a Poisson Process?

    		•
  • Q : What is Sharpe ratio What is Sharpe

    What is Sharpe ratio?

    		•
  • Q : Foreign exchange transactions among

    How are foreign exchange transactions among international banks settled?The interbank market is network of correspondent banking relationships, along with large commercial banks maintaining demand deposit accounts along with one another, known a

    		•
  • Q : $-£ currency swap Assume Morgan

    Assume Morgan Guaranty, Ltd. is quoting swap rates as follows: 7.75 - 8.10 percent annually against six-month dollar LIBOR for dollars and 11.25 - 11.65 percent annually against six-month dollar LIBOR for British pound sterling. At what rates will Morgan Gua

    		•
  • Q : Explain an example of Brownian motion

    Explain an example of Brownian motion effects.

    		•
  • Q : Arbitrage profit and IRP based question

    Presently, the spot exchange rate is $1.50/£ and the three-month forward exchange rate is $1.52/£. The interest rate of three month is equal to 8.0% per annum in the U.S. & 5.8% per annum in the U.K.  One can borrow as much as $1,500,000 o

    		•
  • Q : Kareem construction Show how Kareem's

    Show how Kareem's WACC would change if the tax rate dropped to 25 percent and the estimated cost of equity capital were based on a risk-free rate of 7 percent, a market risk premium of 8 percent, and a systematic risk measure or beta of 2.0.

    		•