Moore School of Business
University of South Carolina
IBUS 401 – INTERNATIONAL FINANCIAL MANAGEMENT
Answers to selected end-of-chapters problems
Chapters 7 and 8
Problems assigned: Chapter 7:
1, 2, 3, 4, 5, 6, 11, 12, 13, 14, 15, 17, 21, 22, 23, 27,
Locational arbitrage can occur when the spot rate of a given currency varies among
locations. Specifically, the ask rate at one location must be lower than the bid rate at another
location. The disparity in rates can occur since information is not always immediately
available to all banks. If a disparity does exist, locational arbitrage is possible; as it occurs,
the spot rates among locations should become realigned.
Yes! One could purchase New Zealand dollars at Yardley Bank for $.40 and sell them to
Beal Bank for $.401. With $1 million available, 2.5 million New Zealand dollars could be
purchased at Yardley Bank. These New Zealand dollars could then be sold to Beal Bank for
$1,002,500, thereby generating a profit of $2,500.
The large demand for New Zealand dollars at Yardley Bank will force this bank's ask price
on New Zealand dollars to increase. The large sales of New Zealand dollars to Beal Bank
will force its bid price down. Once the ask price of Yardley Bank is no longer less than the
bid price of Beal Bank, locational arbitrage will no longer be beneficial.
Triangular arbitrage is possible when the actual cross exchange rate between two currencies
differs from what it should be. The appropriate cross rate can be determined given the values
of the two currencies with respect to some other currency.
Covered interest arbitrage involves the short-term investment in a foreign currency that is
covered by a forward contract to sell that currency when the investment matures. Covered
interest arbitrage is plausible when the forward premium does not reflect the interest rate
differential between two countries specified by the interest rate parity formula. If
transactions costs or other considerations are involved, the excess profit from covered interest
arbitrage must more than offset these other considerations for covered interest arbitrage to be
$1,000,000/$.80 = C$1,250,000 × (1.04)
= C$1,300,000 × $.79
Yield = ($1,027,000 – $1,000,000)/$1,000,000 = 2.7%, which exceeds the yield in the U.S.
over the 90-day period.