A U.S.-based currency dealer has good credit and can borrow $1,000,000 or 800,000 for one year....

 

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A U.S.-based currency dealer has good credit and can borrow $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$= 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one- year forward exchange rate is $1.20 €1.00. Show how to realize a certain euro profit via covered interest arbitrage. Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600. None of these. Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate all dollar back into euro at the forward rate of $1.20 = €1.00. Net profit €2,000. Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$= 2% for one year; translate part of dollar back into euro at the forward rate of $1.20 - €1.00. Net profit $2,400. A U.S.-based currency dealer has good credit and can borrow $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$= 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one- year forward exchange rate is $1.20 €1.00. Show how to realize a certain euro profit via covered interest arbitrage. Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600. None of these. Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate all dollar back into euro at the forward rate of $1.20 = €1.00. Net profit €2,000. Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$= 2% for one year; translate part of dollar back into euro at the forward rate of $1.20 - €1.00. Net profit $2,400.

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The 3rd option is right option Explanation Spot exchange rate SR 125 1 year forward exchange rate FR ... View the full answer