You work for the Royal Bank of Scotland as a currency trader in Sydney, Australia, and can
Question:
You work for the Royal Bank of Scotland as a currency trader in Sydney, Australia, and can borrow 1,000,000 Australian dollars (AUD) or 1,100,000 New Zealand dollars (NZD) for one year. The one-year interest rate in the AUD is iAUD = 8% and the one-year interest rate in the NZD is iNZD = 4%. The spot exchange rate is NZD1.10 = AUD1.00 and the one-year forward exchange rate is NZD1.05 = AUD1.00. Show how to realize a certain AUD-denominated profit via covered interest arbitrage in one year.
a.Borrow AUD 1,000,000 at 8%; exchange 1,000,000 AUD for NZD at the spot rate; and invest NZD at iNZD = 4%. In one year, convert NZD, principal and interest, back into AUD at the forward rate of NZD1.05 = AUD1.00; repay AUD loan; and recognize arbitrage profits of AUD 9,523.81.
b.Borrow AUD 1,000,000 at 8%; exchange 1,000,000 AUD for NZD at the spot rate; and invest NZD at iNZD = 4%. In one year, convert some number of NZD back into AUD at the forward rate of NZD1.05 = AUD1.00; repay AUD loan; and recognize arbitrage profits of NZD 10,000.
c.Borrow NZD 1,100,000 at 4%; exchange 1,100,000 NZD for AUD at the spot rate; and invest AUD at iAUD = 8%. In one year, convert AUD, principal and interest, back into NZD at the forward rate of NZD1.05 = AUD1.00; repay NZD loan; and recognize arbitrage profits of NZD 10,000.
d.Borrow NZD 1,100,000 at 4%; exchange 1,100,000 NZD for AUD at the spot rate; and invest AUD at iAUD = 8%. In one year, convert some number of AUD back into NZD at the forward rate of NZD1.05 = AUD1.00; repay NZD loan; and recognize arbitrage profits of AUD 9,523.81.
International Business
ISBN: 9781292274157
8th Edition
Authors: Simon Collinson, Rajneesh Narula, Alan M. Rugman