As a trader for the AMBS Hedge fund, you see the following price quotes from a bank.
Question:
As a trader for the AMBS Hedge fund, you see the following price quotes from a bank.
The price quotes are valid today:
1-year USD deposit/loan interest rate: 3.5% to 3.625% per annum
Spot exchange rates (bid-ask) USD 1.1602 / GBP USD 1.1642 / GBP
1-year forward exchange rates (bid-ask): USD 1.2500 / GBP; USD 1.2650 / GBP
The interest rates are quoted on a 360-day-year basis.
a) Assume that covered interest rate parity (CIP) holds. Derive the ranges of the
GBP deposit and loan interest rates are consistent with the CIP condition.
b) The following GBP deposit/loan interest rate is offered to you from a different
bank in the external currency market.
1-year GBP deposit/loan interest rate: 1.0% to 1.125% per annum
Explain clearly how covered interest arbitrage can be undertaken, and how the
no-arbitrage equilibrium can be recovered.
International Financial Management
ISBN: 978-0132162760
2nd edition
Authors: Geert Bekaert, Robert J. Hodrick