Assume the following information: Spot rate today of Swiss franc = $.60 1-year f
ID: 2757174 • Letter: A
Question
Assume the following information:
Spot rate today of Swiss franc
=
$.60
1-year forward rate as of today for Swiss franc
=
$.63
Expected spot rate 1 year from now
=
$.64
Rate on 1 year deposits denominated in Swiss francs
=
7%
Rate on 1 year deposits denominated in U.S. dollars
=
9%
From the perspective of Swiss investors with SF1,000,000, covered interest arbitrage would yield a rate of return of ______%.
Show how you calculate your answer.
Spot rate today of Swiss franc
=
$.60
1-year forward rate as of today for Swiss franc
=
$.63
Expected spot rate 1 year from now
=
$.64
Rate on 1 year deposits denominated in Swiss francs
=
7%
Rate on 1 year deposits denominated in U.S. dollars
=
9%
Explanation / Answer
Answer: Form the perspective of Swiss investors, the covered interest arbitrage would yield a rate of return of 3.81%
Calculations:
Step 1 - Convert today, the SF 1000000 to $ at spot rate to yield $600000 (1000000*0.6)
Step 2 - Invest $600000 today in $ deposits for 1 year @ 9%--Maturity value 600000*1.09=$654000
Simultaneously enter into a forward contract for sale of $ at the 1 year forward rate of $/SF of 0.63
Step 3 - At the end of the year close the $ deposit of $654000, convert it to SF @ 1/0.63 to get SF1038095.24
Yeild then would be {(1038095.24/1000000) - 1}*100 = 3.81%
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