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Unformatted text preview: 1. An arbitrage is best defined as: a) The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits. 2. Interest Rate Parity (IRP) is best defined as: a) An arbitrage condition that must hold when international financial markets are in equilibrium 3. When Interest Rate Parity (IRP) does not hold a) there are opportunities for covered interest arbitrage 4. A formal statement of IRP is a) 5. Suppose that the oneyear interest rate is 5.0 percent in the United States, the spot exchange rate is $1.20/, and the oneyear forward exchange rate is $1.16/. What must oneyear interest rate be in the euro zone? a) 8.62% 6. Suppose that the oneyear interest rate is 3.0 percent in the Italy, the spot exchange rate is $1.20/, and the oneyear forward exchange rate is $1.18/. What must oneyear interest rate be in the United States? a) 1.2833% 7. A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The oneyear interest rate in the U.S. is i $ = 2% and in the euro zone the oneyear interest rate is i = 6%. The spot exchange rate is $1.25 = 1.00 and the oneyear forward exchange rate is $1.20 = 1.00. Show how to realize a certain profit via covered interest arbitrage. a) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i $ = 2% for one year; translate 848,000 back into euro at the forward rate of $1.20 = 1.00. Net profit $2,400. b) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i $ = 2% for one year; translate 850,000 back into euro at the forward rate of $1.20 = 1.00. Net profit 2,000. c) Answers c) and b) are both correct 8. Suppose that you are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U.S. Tbills that yield 1.810% (thats a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = 100, and the six month forward rate is $1.00 = 110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy? a) take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the forward contract 9. A U.S.based currency dealer has good credit and can borrow $1,000,000 for one year. The one year interest rate in the U.S. is i $ = 2% and in the euro zone the oneyear interest rate is i = 6%. The spot exchange rate is $1.25 = 1.00 and the oneyear forward exchange rate is $1.20 = 1.00. Show how to realize a certain dollar profit via covered interest arbitrage....
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This note was uploaded on 03/30/2010 for the course CHM chemisty l taught by Professor ? during the Spring '10 term at University of North Carolina Wilmington.
 Spring '10
 ?
 Equilibrium

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