11. spot rate for the dollar is 0.1432 $/ADF. Andorran and U.S. interest rates are 6.6% and 7.2%, respectively. If the 1-year forward rate is 0.1430 $/ADF, a U.S. investor could earn an arbitrage dollar profit per ADF of:

A)   $0.0011.

B)   $0.0010.

C)   $0.0075.

D)   $0.0060.

12.en the following information:

§ The forward rate between dollars and pounds is 1.66$/GBP.

§ The current spot rate is 1.543 $/GBP.

§ The UK interest rate is 5.77%.

§ The interest rate in the United States is 5.976%.

Assume a U.S. investor can borrow pounds or dollars. What is the covered interest rate differential?

A)   0.07661.

B)   0.6786.

C)   -0.07814.

D)   Covered interest differential is zero.

13.1 + the domestic interest rate < (1 + the foreign interest rate * the forward rate)/spot rate, an investor seeking arbitrage profits should borrow:

A)   foreign, lend out domestic, and convert back to domestic.

B)   domestic, lend out foreign, and convert back to domestic.

C)   domestic, convert to foreign, borrow foreign, and convert back to domestic.

D)   foreign, convert to domestic, lend out domestic, and convert back to foreign.

14.pose that the current interest rates in the U.S. and the European Union are 13.665 percent and 8.5000 percent, respectively. Also, the spot rate for the dollar is 1.1975 US$/euro, and the 1-year forward rate is 1.2545 US$/euro. If $100 is invested, what is the total arbitrage profit that a U.S. investor could earn?

A)   No arbitrage profit can be made.

B)   $23.06700.

C)   $5.70000.

D)   $0.23067.

15.nifer Nance has recently been hired as an analyst at the Central City Bank in the currency trading department. Nance, who recently graduated with a degree in economics, will be working with other analysts to determine if there are profit opportunities in the foreign exchange market.

Nance has the following data available:

Assume borrowing and lending rates are equal and bid-ask spreads are zero in the spot and forward markets. Using the data above, Nance is asked to calculate the profits in pounds from covered interest arbitrage between the United Kingdom and the United States, assuming an investor starts by borrowing ₤500,000. The answer is:

A)   ₤36,585.37.

B)   ₤6,750.00.

C)   ₤56,750.00.

D)   ₤6,585.37.

11. spot rate for the dollar is 0.1432 $/ADF. Andorran and U.S. interest rates are 6.6% and 7.2%, respectively. If the 1-year forward rate is 0.1430 $/ADF, a U.S. investor could earn an arbitrage dollar profit per ADF of:

A)   $0.0011.

B)   $0.0010.

C)   $0.0075.

D)   $0.0060.

The correct answer was A)

Let us first check if an arbitrage opportunity exists. Applying the interest rate parity theorem, we have:

Forward rate = 0.1432 x 1.072/1.066 = 0.1440 $/ADF > 0.1430 $/ADF (quoted forward rate)

This implies that an arbitrage opportunity exists. The inequality implies that ADF is mispriced (weak) in the forward market or is underpriced relative to the dollar. We should buy ADF in the forward market and sell the dollar in the spot market. This requires that we borrow in Andorra and convert the francs into dollars at the spot rate. Invest the proceeds in U.S. securities @ 7.2%, and simultaneously enter into a forward transaction where we sell the dollars for ADF @ 0.1430 $/ADF. Assuming that we borrow 1 ADF today and convert it into dollars, we will have 0.1432 dollars to invest at 7.2% for one year. After one year we will have 0.1432 x 1.072 = 0.1535 dollars. At that point, we will owe an Andorran bank 1 x 1.066 or 1.066 ADF, including interest. We will need to convert enough dollars at the forward rate to pay off this loan. At the forward contract rate, we will need to convert 1.066 x 0.1430 = 0.1524 dollars into ADF to pay off our obligation. This will leave us with an arbitrage profit of 0.1535 – 0.1524 = 0.0011 dollars.

12.en the following information:

§ The forward rate between dollars and pounds is 1.66$/GBP.

§ The current spot rate is 1.543 $/GBP.

§ The UK interest rate is 5.77%.

§ The interest rate in the United States is 5.976%.

Assume a U.S. investor can borrow pounds or dollars. What is the covered interest rate differential?

A)   0.07661.

B)   0.6786.

C)   -0.07814.

D)   Covered interest differential is zero.

The correct answer was C)

(1 + r_D) – [(1 + r_F)(forward rate)]/spot rate] = Covered Interest Differential

(1 + 0.05976) – [(1 + 0.0577)(1.66)]/1.543 =

1.05976 – [(1.0577)(1.66)]/1.543 =

1.05976 – (1.75578/1.543) =

1.05976 – 1.13790 = -0.07814

13.1 + the domestic interest rate < (1 + the foreign interest rate * the forward rate)/spot rate, an investor seeking arbitrage profits should borrow:

A)   foreign, lend out domestic, and convert back to domestic.

B)   domestic, lend out foreign, and convert back to domestic.

C)   domestic, convert to foreign, borrow foreign, and convert back to domestic.

D)   foreign, convert to domestic, lend out domestic, and convert back to foreign.

The correct answer was B)

If 1 + r_D < (1 + r_F)(forward rate)/spot rate, then borrow domestic, lend out foreign, and convert back to domestic.

14.pose that the current interest rates in the U.S. and the European Union are 13.665 percent and 8.5000 percent, respectively. Also, the spot rate for the dollar is 1.1975 US$/euro, and the 1-year forward rate is 1.2545 US$/euro. If $100 is invested, what is the total arbitrage profit that a U.S. investor could earn?

A)   No arbitrage profit can be made.

B)   $23.06700.

C)   $5.70000.

D)   $0.23067.

The correct answer was A)

First determine if an arbitrage opportunity exists by

(1 + r_D) = [(1 + r_F)(forward rate)]/spot rate = Covered Interest Differential

If the covered interest differential is > or < 0 then arbitrage opportunities exist.

(1 + 0.13665) = [(1 + 0.085)(1.2545)/1.1975] =

1.13665 = [(1.085)(1.2545)/1.1975] =

1.13665 = 1.36113/1.1975 =

1.13665 = 1.13665 = 0, therefore no arbitrage profit can be made.

15.nifer Nance has recently been hired as an analyst at the Central City Bank in the currency trading department. Nance, who recently graduated with a degree in economics, will be working with other analysts to determine if there are profit opportunities in the foreign exchange market.

Nance has the following data available:

Assume borrowing and lending rates are equal and bid-ask spreads are zero in the spot and forward markets. Using the data above, Nance is asked to calculate the profits in pounds from covered interest arbitrage between the United Kingdom and the United States, assuming an investor starts by borrowing ₤500,000. The answer is:

A)   ₤36,585.37.

B)   ₤6,750.00.

C)   ₤56,750.00.

D)   ₤6,585.37.

The correct answer was D)

In this example, covered interest arbitrage involves borrowing pounds at the U.K. interest rate, converting to dollars at the spot rate, investing the dollars at the U.S. interest rate, converting the dollar investment proceeds back to pounds at the forward rate, and repaying the pound loan. Arbitrage profits are the difference between the proceeds from the forward contract and the amount repaid on the loan.

We start by borrowing 500,000. At a borrowing rate of 6.0%, we will have to repay 500,000(1.06) = 530,000 at the end of the year.

We convert the 500,000 pounds to dollars at the spot rate of $1.6000, which gives us 500,000 * $1.6000/ = $800,000.

We invest $800,000 for one year at 10.0%, and at the end of the year we receive $800,000(1.10) = $880,000.

This means that initially we must enter into a forward contract at $1.6400 and then at the end of the year convert $880,000 into $880,000/$1.6400 = 536,585.37.

We pay back the 530,000 loan balance and our arbitrage profits are 536,585.37 - 530,000 = 6,538.37.