Question 1. You, a foreign exchange trader for Green Valley Capital, are exploring covered interest arbitrage opportunities between Euros (C) and US Dollar ($) for the next 60 days.
You have € 1 million or $ 1.1 million at the current spot rate for the covered interest arbitrage and face the following quotes:
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Arbitrage fund available
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€1,000,000 or $1,100,000
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Spot exchange rate
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$1.1000/C
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60-day forward rate
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$1.1040/C
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US Dollar annual interest rate
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1.8% |
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Euro annual interest rate
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0.90% |
1(A) What is the annual effective US Dollar interest rate from Euro investment?
1(B) Show the steps and calculate the amount of the covered interest arbitrage profit
1(C) Determine a theoretical 6o-day forward rate (round to 4 decimal places) that will result in a zero covered interest arbitrage profit.
1(D) The following appeared in the Feb. 4, 2016 Wall Street Journal article "Dollar Continues to Fall Ahead of Friday's Jobs Report":
Investors have been fleeing the dollar in recent days, amid expectation that the Federal Reserve won't be able to raise interest rates as much as expected this year due to soft growth in the U.S. and turbulent global markets. Such persistently low interest rates weigh on the U.S. currency, as they make the dollar less attractive to yield-seeking investors. The dollar has now fallen 2.6% against a basket of currencies in February.
Explain (not more than half of a page) the above narrative with the interest rate parity relationship.
Question 2. You, a foreign exchange trader for Green Valley Capital, observe that the spot rate between Chinese Yuan and US Dollar (V/$) has been holding steady, and both Dollar and Yuan interest rates have remained relatively fixed over the past week. Your research associates at Green Valley Capital are predicting the spot rate to remain close to current spot rate thr the coming month.
You decide to make an uncovered interest arbitrage investment for one month to take advantage of the interest rate difference between Dollar and Yuan. You have Si million or Y. 6.4 million at the current spot rate for the uncovered interest arbitrage and face the following quotes:
2(A) Show the steps and calculate the amount of the uncovered interest arbitrage profit if the spot rate becomes Y 6.4300/$ one month later.
2(B) Determine the break even spot rate V/$ (round to 4 decimal places) one month later that will result in a zero uncovered interest arbitrage profit.
2(C) The following appeared in the Aug. 18, 2015 Wall Street Journal article "Yuan's Devaluation Brings Losses for Some":
Tactics involve borrowing U.S. dollars to take advantage of low American interest rates while simultaneously making yuan deposits in higher-
yielding, yuan-denominated wealth-management products, fixed-income investments and certificates of deposit, in a bask foreign-exchange play called a carry trade.
Some wealth advisers promise to turn a 3% annualized return into a 10% gain. But a prerequisite for a profit is that the yuan doesn't fall. Suddenly.
Many of those deals are threatened.
Explain (in about half of a page) with your answers in parts A and B how sudden Yuan devaluation threatens the carry trade strategy. You must include the closing historical exchange rates (round to 4 decimal places) between Yuan and Dollar from Aug. 6, 2015 to Aug. 14, 2015 (a total of 7 U.S. business days) to support your explanation. You can use www.investing.com to retrieve the historical rates.