Problem 3 Currently, the spot exchange rate is $1.2700/ and the forward exchange rate, with one-year...
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Problem 3 Currently, the spot exchange rate is $1.2700/ and the forward exchange rate, with one-year maturity, is $1.2500/. The annual interest rate is 1.0 percent in the U.S. and 2.5 percent in the euro zone. Assume that you can borrow as much as $1,270,000 or 1,000,000. a. Calculate the covered yield (dollar rate of return without taking any exchange rate risk) for the euro (). Use this equation: Sb (SFr/) = Sb ($/) Sb (SFr/$) b. Determine whether interest rate parity (IRP) is currently holding. c. If the IRP is not holding, how would you carry out covered interest arbitrage (CIA)? Show step-by-step process and the arbitrage profit. d. Explain how IRP will be restored because of the CIA activities Problem 3 Currently, the spot exchange rate is $1.2700/ and the forward exchange rate, with one-year maturity, is $1.2500/. The annual interest rate is 1.0 percent in the U.S. and 2.5 percent in the euro zone. Assume that you can borrow as much as $1,270,000 or 1,000,000. a. Calculate the covered yield (dollar rate of return without taking any exchange rate risk) for the euro (). Use this equation: Sb (SFr/) = Sb ($/) Sb (SFr/$) b. Determine whether interest rate parity (IRP) is currently holding. c. If the IRP is not holding, how would you carry out covered interest arbitrage (CIA)? Show step-by-step process and the arbitrage profit. d. Explain how IRP will be restored because of the CIA activities
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