Assignment-3 - Session 4 Chapter 7 7 Covered Interest...

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Unformatted text preview: Session 4, Chapter 7 7. Covered Interest Arbitrage. Assume the following information: Spot rate of Mexican peso = $.100 180-day forward rate of Mexican peso = $.098 180-day Mexican interest rate = 6% 180-day U.S. interest rate = 5% Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer. ANSWER: To answer this question, begin with an assumed amount of pesos and determine the yield to Mexican investors who attempt covered interest arbitrage. Using MXP1,000,000 as the initial investment: MXP1,000,000 × $.100 = $100,000 × (1.05) = $105,000/$.098 = MXP1,071,429 Mexican investors would generate a yield of about 7.1% ([MXP1,071,429 – MXP1,000,000]/ MXP1,000,000), which exceeds their domestic yield. Thus, it is worthwhile for them. 31. Implications of IRP. Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is nominal interest rate in the U....
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Assignment-3 - Session 4 Chapter 7 7 Covered Interest...

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