Casper landsten cia assumptions value sfr equivalent

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Problem 7.11 Casper Landsten -- CIAAssumptionsValueSFr. EquivalentArbitrage funds available$1,000,000SFr. 1,281,000Spot exchange rate (SFr./$)1.2810 3-month forward rate (SFr./$)1.2740 U.S. dollar 3-month interest rate4.800%Swiss franc3-month interest rate3.200%Casper Landsten is a foreign exchange trader for a bank in New York. He has $1 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 covered interest arbitrage investment in the Swiss franc. He faces the following quotes:Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency.Difference in interest rates ( i SFr. - i $)-1.600%Forward premium on the Swiss franc2.198%CIA profit potential0.598%U.S. dollar interest rate (3-month)START4.800%END$1,000,000.00 1.0120 $1,012,000.00 1,013,538.46 $1,538.46 Spot (SFr./$)---------------> 90 days ---------------->Forward-90 (SFr./$)1.28101.2740SFr. 1,281,000.001.0080 SFr. 1,291,248.003.200%Swiss franc interest rate (3-month)
This 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.a) Casper Landsten makes a net profit, a covered interest arbitrage profit, of $1,538.46 on each million he invests in the Swiss franc market (by going around the box). He should therefore take advantage of it and perform covered interest arbitrage.b) Assuming a $1 million investment for the 90-day period, the annual rate of return on this near risk-less investment is:
Problem 7.12 Casper Landsten -- UIACasper Landsten, using the same values and assumptions as in the previous question, now decides to seek the full 4.800% return available in US dollars by not covering his forward dollar receipts -- an uncovered interest arbitrage (UIA) transaction. Assess this decision. AssumptionsValueSFr. EquivalentArbitrage funds available$1,000,000SFr. 1,281,000Spot exchange rate (SFr./$)1.2810 3-month forward rate (SFr./$)1.2740 Expected spot rate in 90 days (SFr./$)1.2700 U.S. dollar 3-month interest rate4.800%Swiss franc3-month interest rate3.200%STARTU.S. dollar interest rate (3-month)END4.800%$1,000,000 1.0120 $1,012,000.00 $1,012,029.16 $29.16 Spot (SFr/$)---------------> 90 days ---------------->Expected Spot (SFr/$)1.28101.2759SFr. 1,281,0001.0080 SFr. 1,291,2483.200%Swiss franc interest rate (3-month)Since Casper is in the US market (starting point), if he were to undertake uncovered interest arbitrage he would be first exchange dollars for Swiss francs, investing the Swiss francs for 90 days, and then exchanging the Swiss franc proceeds (principle and interest) back into US dollars at whatever the spot rate of exchange is at that time. In this case Casper will have to -- at least in his mind -- make some assumption as to what the exchange rate will be at the end of the 90 day period. If Casper assumed the spot rate at the end of 90 days were the same as the current spot rate (SFr1.2810/$), the UIA

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