Review Homework 6.pdf - Worked Solution The assumptions for...

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Worked Solution The assumptions for this problem are: Assumptions Arbitrage funds available $ 5,000,000 Spot rate (¥/$) 118.56 180-day forward rate (¥/$) 117.88 U.S. dollar annual interest rate 4.804 % Japanese yen annual interest rate 3.391 % To calculate the CIA profit potential, follow the steps below: First, calculate the difference in the interest rates using the following formula: Difference in = − interest rates 2 Japanese yen interest rate U.S. dollar interest rate Difference in = 3.391% − 4.804% = −1.413% interest rates Next, calculate the forward premium on the yen using this formula: Forward premium = on the yen Spot rate − Forward rate Forward rate × 360 Days Forward premium = = 1.154% on the yen ¥ 118.56 / $ − ¥ 117.88 ¥ 117.88 / $ / $ × 360 180 Finally, calculate the CIA profit potential using the following formula: CIA profit = + potential Difference in interest rates Forward premium on the yen CIA profit = − 1.413% + 1.154% = − 0.259% potential The CIA profit potential is −0.259 %, which tells Takeshi Kamada that he should borrow the Japanese yen and invest in the higher yielding currency, the U.S.dollar, to lock in a covered interest arbitrage (CIA) profit.
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