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The annual interest rate is 8.02% in Mexico and 7.45% in Canada. The spot peso-dollar exchange rate is 569.87 MXN/CAD, and the one-year forward rate is 526.78 MXN/CAD. If an arbitrage opportunity exists, how much would a person living in Mexico make borrowing 15,000,000 pesos or the equivalent in Canadian dollars?
Note that peso is at a forward premium (less pesos per CAD in the future) and that peso interest rate is higher. Therefore it is clear there are arbitrage profits from lending in pesos and borrowing CAD.
First convert to Canadian dollars to determine the amount of interest due at the end of the year. (15,000,000 MXN) × (CAD/569.87 MXN) = 26,321.79 CAD.
26,321.79 CAD × 0.0745 = 1,960.97 CAD interest due at the end of the year.
Lend out pesos 15,000,000 pesos × 1.0802 = 16,203,000 pesos received at the end of the year.
Convert to Canadian dollars (16,203,000 MXN) × (CAD/526.78 MXN) = 30,758.57 CAD.
Subtract the original loan amount and interest: 30,758.57 − 26,321.79 (original loan) − 1,960.97 (interest) = 2,475.81 CAD profit.
Convert the remainder back to pesos: (2,475.81 CAD) × (526.78 MXN/CAD) = 1,304,207.19 peso profit. |
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