You are a currency analyst for Morgan Stanley on Wall Street for which you are c
ID: 2627315 • Letter: Y
Question
You are a currency analyst for Morgan Stanley on Wall Street for which you are charged with searching for money machines (Arbitrage opportunities). You notice something seems funny with the Canadian Dollar as the government is rumored to be purposely undermining the CD in an attempt to boost the general economy as the country is highly dependent on exports. The current exchange rate is CD1.0375/$ and the Forward rate is CD1.0295/$. Your first inclination is to go to the credit markets and find out what 1 yr. risk free assets are yielding in Canada and the United States which are: 4.927% in the United States and 3.879% in Canada.
Is there an arbitrage opportunity that you can exploit with the information given? If you determine so what is the profit if you start by borrowing CD90Million? You are to use European or indirect quotes in your calculations.
Explanation / Answer
by selling CD 90 million for $ = 90/1.0375 million $
investing this dollar amount in US after one year final amount = (1+0.04927)*90/1.0375 million $
after one year converting this amount in CD = (1+0.04927)*90*1.0295/1.0375 = CD 93.706 million
final amount to be paid to lender = 90*(1+0.03879) = CD 93.491 million
profit = 93.706-93.491 = CD 0.215 million
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