Ask Question
BusinessBusiness
20 February, 07:53

CIRP. Jason Smith is a foreign exchange trader with Citibank. He notices the following quotes. Spot exchange rate SFr1.6627/$ Six-month forward exchange rate SFr1.6558/$ Six-month $ interest rate 3.5% per year Six-month SFr interest rate 3.0% per year a. Ignoring transaction costs, is the interest rate parity holding? b. Now assume that the forward exchange rate is not given, but that the spot forward exchange rate and two interest rates are given as above. Determine the forward exchange rate. c. Going back to the four numbers given above, what steps would be needed to make an arbitrage profit? Assuming that Jason Smith is authorized to work with $1,000,000 for this purpose, how much would the arbitrage profit be in dollars?

+3
Answers (1)
  1. 20 February, 08:32
    0
    Answer explained below

    Explanation:

    A.

    For six months, rSFr = > 1.50% and r$ = > 1.75%.

    Since the exchange rate is in SFr/$ terms, the appropriate expression for the interest rate parity relation is

    F/S = > [ (1 + rSFr) / (1 + r$) ]

    then we can also say

    F/S * (1 + r$) = > (1 + rSFr)

    Now Left side = > F/S * (1 + r$) = > [ (1 + 6.558) / ( + 1.6627) ] * (1 + 0.0175)

    Left side = > 1.0133

    and Right side = > (1 + rSFr) = > 1.0150

    Since the left and right sides are not equal, IRP is not holding.

    B and C.

    Since IRP is not holding, there is an arbitrage possibility.

    As 1.0133 < 1.0150,

    we can say that the EuroSFr quote is more than what it should be as per the quotes for the other three variables. And, we can also say that the Euro$ quote is less than what it should be as per the quotes for the other three variables. Therefore, the arbitrage strategy should be based on borrowing in the Euro$ market and lending in the SFr market. The steps are as as follows. -

    Borrow $1000000 for six-months at 3.5% per year and then we will pay back

    => $1000000 * (1 + 0.0175) = > $1,017,500 six months later.

    Convert $1000000 to SFr at the spot rate to get SFr 1662700.

    Lend SFr 1662700 for six-months at 3% per year. Will get back

    => SFr1662700 * (1 + 0.0150) = > SFr 1,687,641 six months later.

    Sell SFr 1687641 six months forward. The transaction will be contracted as of the current date but delivery and settlement will only take place six months later. So, sixmonths later exchange

    SFr 1,687,641 for = > SFr 1687641 ⁄ SFr 1.6558/$ = > $1,019,230.

    The arbitrage profit six months later is 1019230 - 1017500 = $1,730
Know the Answer?
Not Sure About the Answer?
Get an answer to your question ✅ “CIRP. Jason Smith is a foreign exchange trader with Citibank. He notices the following quotes. Spot exchange rate SFr1.6627/$ Six-month ...” in 📙 Business if there is no answer or all answers are wrong, use a search bar and try to find the answer among similar questions.
Search for Other Answers
You Might be Interested in
When different invest Assume Evco, Inc. has a current stock price of $ 50.00 and will pay a $ 2.00 dividend in one year; its equity cost of capital is 15 %.
Answers (1)
Larkspur, Inc. exchanges old delivery equipment for new delivery equipment. The book value of the old delivery equipment is $36,900 (cost $66,400 less accumulated depreciation $29,500). Its fair value is $45,500, and cash of $5,300 is paid.
Answers (1)
With the indirect method for determining net cash flows from operations, depreciation is: a. subtracted from net income. b. subtracted from working capital. c. ignored because it does not provide or use cash. d. added to net income.
Answers (1)
A company doing marketing research finds that a 10 percent decrease in its product's price would create a 5 percent increase in the quantity demanded of its product. a. Based on this information, demand for the company's product is. b.
Answers (1)
When it comes to pay satisfaction, most employees base their desired pay on their job duties and: Select one: A. the potential for promotions their basic needs B. their status the pay received by their superiors C.
Answers (1)
New Questions in Business
Refer to Exhibit 5-5. If the airline charges price P1 for both aisle seats and middle seats, the result will be Group of answer choices a surplus of middle seats and the equilibrium quantity of aisle seats.
Answers (1)
If the cpi is 100 in the base year and 108 in the current year, how much did prices rise between the base year and the current year?
Answers (1)
In previous years, Cox Transport reacquired 2 million treasury shares at $20 per share and, later, 1 million treasury shares at $26 per share.
Answers (1)
On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount.
Answers (1)
Mustang Corporation has accumulated the following accounting data for the month of April: Finished goods inventory: April 1 $30,600 Finished goods inventory: April 30 25,000 Total cost of goods manufactured: 116,400a. $125,000 b. $174,200 c.
Answers (1)
Home » Business » CIRP. Jason Smith is a foreign exchange trader with Citibank. He notices the following quotes. Spot exchange rate SFr1.6627/$ Six-month forward exchange rate SFr1.6558/$ Six-month $ interest rate 3.5% per year Six-month SFr interest rate 3.
Sign Up Forgot Password?