1. Covered Interest Arbitrage. Assume the following: Spot rate of Mexican = $ .1
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Question
1. Covered Interest Arbitrage.Assume the following:
Spot rate of Mexican = $ .100
180-days forward rate of Mexican peso = .098
180-days Mexican interest rate = 6%
180-days U.S. interest rate = 5%
Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer.
2. Implications of IRP.
Assume that interest rate parity exists. You expect that the one year nominal interest rate in the United States is 7 percent, while the one year nominal interest rate in Australia dollar is 11 percent. The spot rate of Australian dollars is $.60. You will need 10 million Australian dollars in one year. Today, you purchase a one year forward contract in Australian dollars. How many U.S. dollars will you need in one year to fulfill you forward contract?
3. forecasting the future spot rate based on IFE
Assume that the spot exchange rate of the Singapore dollar is $.70. The one year interest rate is 11 percent in the United States and 7 percent in Singapore. What will the spot rate be in one year according to the IFE? What is the force that causes the spot rate to change according to the IFE?
4. Implications of ppp
Today’s spot rate of the Mexican peso in $.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7 percent, while the Mexican inflation over this year is expected to be 3 percent. Wake forest Co. plans to import from Mexico and will need 20 million Mexican pesos in one year. Determine the expected amount of dollars to be paid by the wake Forest Co. for the peso in one year.
Explanation / Answer
We assume an amount of pesos and determine the yield to investors who attempt covered interest arbitrage that is Mexican, using MXP 1,000,000 as the beginning investment. MXP 1,000,000 * $0.100 = $100,000 * 1.05 = $105,000 / $0.098 = MXP 1,071,429 Yield generated by Mexican investors Yield = (MXP 1,071,429 - MXP 1,000,000) / MXP 1,000,000 = MXP 71,429 / MXP 1,000,000 = 0.071 or 7.1% This is greater than its domestic yield of 6% Hence, covered interest arbitrage is worthwhile for them.
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