Assume that annual interest rates are 5 percent in the United States and 4 perce

Question

Assume that annual interest rates are 5 percent in the United States and 4 percent in Turkey. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is $O.6G24/Turkish lira (TL). a. If the forward rate is $O.6735/TL, using the arbitrage, what is the spread earned by the bank using a sum of $5 million? (Round your answer to 4 decimal places.(e.g., 32.1616)) Spread earned % b. At what forward rate is this arbitrage eliminated? (Round your answer to 5 decimal places. (e.g., 32.16161)) Forward rate /TL

Explanation / Answer

a. Steps to be foolow:

- Borrow $5,000,000 @ 5% for one year
- Convert it in TL using spot rate = 5,000,000 / 0.6624 = 7,548,309.18 TL
- Invest 7,548,309.18 TL @ 4% for one year
- Amount of TL receive after one year = $7,548,309.18 x 1.04 = 7,850,241.55 TL
- Convert the TL into $ at forward rate = 7,850,241.55 x 0.6735 = $5,287,137.68
- Amount of $ loan to be repaid after one year = 5,000,000 x 1.05 = $5,250,000
- Arbitrage profit = 5,287,137.68 - 5,250,000 = $37,137.68
- Spread Earned in % = 37,137.68 / 5,000,000 = 0.0074 or 0.74%

b. Forward rate at which arbitrage will be eliminated = 0.6624 x (1 + 0.05) / (1 + 0.04) = $0.6688/TL

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