The 1-year risk-free interest rate of investments in US dollars is TUSD = 1.46%. The 1-year...

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The 1-year risk-free interest rate of investments in US dollars is TUSD = 1.46%. The 1-year risk-free interest rate of investments in Canadian dollars is TCAD = 3.4%. The current (spot) exchange rate between the two currencies is 1.41: the price of 1 USD is 1.41 CAD. The 1-year forward price of 1 USD is 1.41 CAD. You can trade in 1-year risk-free discount bonds denominated in both US and Canadian dollars, in the forward contract to buy 1 USD 1 year from now, and in the spot foreign exchange market, where you can buy and sell USD. Consider the following strategy: 1. Borrow a USD at 1.46% today, which means that the total loan repayment obligation after a year would be (1 + 1.46%) x USD. 2. Convert y USD into CAD at the spot rate of 1.41. 3. Lock in the 3.4% rate on the deposit amount of 1.41y CAD, and simultaneously enter into a forward contract that converts the full maturity amount of the deposit into USD at the one-year forward rate of USD = 1.41 CAD. 4. After one year, settle the forward contract at the contracted rate of 1.41. Suppose the above arbitrage strategy generates 100 USD today and nothing otherwise, please solve for x and y The 1-year risk-free interest rate of investments in US dollars is TUSD = 1.46%. The 1-year risk-free interest rate of investments in Canadian dollars is TCAD = 3.4%. The current (spot) exchange rate between the two currencies is 1.41: the price of 1 USD is 1.41 CAD. The 1-year forward price of 1 USD is 1.41 CAD. You can trade in 1-year risk-free discount bonds denominated in both US and Canadian dollars, in the forward contract to buy 1 USD 1 year from now, and in the spot foreign exchange market, where you can buy and sell USD. Consider the following strategy: 1. Borrow a USD at 1.46% today, which means that the total loan repayment obligation after a year would be (1 + 1.46%) x USD. 2. Convert y USD into CAD at the spot rate of 1.41. 3. Lock in the 3.4% rate on the deposit amount of 1.41y CAD, and simultaneously enter into a forward contract that converts the full maturity amount of the deposit into USD at the one-year forward rate of USD = 1.41 CAD. 4. After one year, settle the forward contract at the contracted rate of 1.41. Suppose the above arbitrage strategy generates 100 USD today and nothing otherwise, please solve for x and y

Answer rating: 100% (QA)

This is a covered interest arbitrage opportunity which involves borrowing in one currency conv... View the full answer