a. Assume you are a trader with Deutsche Bank. From the quote screen on your computer terminal, you notice that Dresdner Bank is quoting €0.855/$1.00 Credit Suisse is offering SF1.1825/$1.00. UBS’s current direct quoting €/SF currently @ € 0.754/SF
i. Prove and explain whether at these quoted rates there a chance for triangular arbitrage (Hint: Use the no arbitrage cross exchange rate here).
ii. Show and explain how you can make a triangular arbitrage profit by trading at these prices. (Ignore bid-ask spreads for this problem.) Assume you have $5,000,000 with which to conduct the arbitrage. If your answer in a is that there is no chance of arbitrage profits please say so.
b. Assume the following information: You have $400,000 to invest: Current spot rate of Sudanese dinar (SDD) = $.00570 90-day forward rate of the dinar = $.00569 90-day interest rate in the U.S. = 4.0% 90-day interest rate in Sudan = 4.2% Show and explain how given the information above you will conduct covered interest arbitrage, what amount will you have after 90 days.
c. Lakonisho Equipment has an investment opportunity in Europe. The project costs €10.5 million and it is expected to produce cash flows of €1.7 million, €2.4 million, and €3.3 million, for years 1, 2 and 3 respectively. The current spot exchange rate is $1.36/€; the current risk-free rate in the United States is 2.3%, compared to that in Europe of 1.8%. The appropriate discount rate for the project is estimated to be 13%, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of the 3 years for an estimated €7.5 million. What is the NPV of the project? What is the IRR of the project? Should Lakonisho Invest in this project?