Casper Landsten-CIA (A). Casper Landsten is a foreign exchange trader for a bank

Question

Casper Landsten-CIA (A). Casper Landsten is a foreign exchange trader for a bank in New York. He has

$0.90.9

million (or its Swiss franc equivalent) for a short term money market investment and wonders if he should invest in U.S. dollars for three months, or make a CIA investment in the Swiss franc. He faces the following quotes:

Arbitrage funds available

$

900,000

Spot exchange rate (SFr/$)

1.2805

3-month forward rate (SFr/$)

1.2736

U.S. Dollar annual interest rate

4.803

%

Swiss franc annual interest rate

3.204

%

The CIA profit potential is

0.5680.568%,

which tells Casper Landsten he should borrow

U.S. dollars

and invest in the

lower

yielding currency, the

Swiss franc

,

in order to earn covered interest arbitrage (CIA) profits.(Round to three decimal places and select from the drop-down menus.)

The CIA profit amount is

$1317.251317.25.

(Round to the nearest cent.)

Casper Landsten-UIA (B). Casper Landsten is a foreign exchange trader for a bank in New York. Using the values and assumptions below, he decides to seek the full 4.802% return available in U.S. dollars by not covering his forward dollar receipts—an uncovered interest arbitrage (UIA) transaction. Assess this decision.

Arbitrage funds available

$

900,000

Spot exchange rate (SFr/$)

1.2805

3-month forward rate (SFr/$)

1.2738

Expected spot rate in 90 days (SFr/$)

1.2704

U.S. Dollar annual interest rate

4.802

%

Swiss franc annualinterest rate

3.198

%

The uncovered interest arbitrage (UIA) profit amount is $

Arbitrage funds available

$

900,000

Spot exchange rate (SFr/$)

1.2805

3-month forward rate (SFr/$)

1.2736

U.S. Dollar annual interest rate

4.803

%

Swiss franc annual interest rate

3.204

%

Explanation / Answer

Step 1 : Borrow $ 900,000 and convert it into SFR and invest it at 3.198% p.a for 3 months.

Amount in SFR invested at T=0: $900000 x 1.2805 = SFR 1152450

Step 2: Amount of payoff after 3 months = SFR 1152450 + (3.198/4)% of SFR 1152450

= SFR 1161664

Step 3: Since it is not a covered int. arbitrage, it will be sold at Expected spot rate after 90 days

There $ receivable after 90 days (inflow) = (1161664/1.2704) = $ 914407.9

Step 4: $ borrowed amount repayable after 3 months ( outflow) = 900000 x (4.802/4)% + 900000

= $ 910804.5

Therefore Covered interest arbitrage amount = Inflow - Outflow

= $ 914407.9 - $910804.5 = $ 3603.4

  

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