Suppose there is an interest rate spread of 1% between the United States and Sou
ID: 2723145 • Letter: S
Question
Suppose there is an interest rate spread of 1% between the United States and South Africa (S.A.). The yield on a one-year U.S. Treasury security is 5% (rd = 5%) while the yield on a comparable South African security is 6% (rF = 6%). You wish to invest $50,000. The indirect quote for the rand-dollar (R/$) spot exchange rate is 7 South African rand (R7) per dollar. Suppose you invest your funds in U.S. securities for 6 months. Calculate the future value of your investment
a. $51,500 b.$50,500 c. $51,250 d. $53,000 e. none of the obove
If you chose, instead, to invest your funds in South African securities for 6 months, what is the future value of your investment?
a. R 53,000 b. R 360,500 c. R 358,750 d. R 51,500 e. R 371,000
To cover your South African investment, you execute a covered interest arbitrage by selling a six-month forward contract in rand. What is the dollar equivalent of your S.A. investment if the 6-month forward rate is R7.125?
a. $49,122.81 b. $50.589.49 c. $2,568,562.50 d. $51,500 e. none of the above
What forward rate would cause you to be indifferent between investing your money in U.S. securities versus investing in S.A.? Note that at this forward rate, interest rate parity holds.
a. R 7.2390 b. R 7.0341 c. R 6.8019 d. none of the above
Explanation / Answer
1.
Future Value=Investment(1+r)n=$50,000*(1+0.05/2)=$50,000*1.025=$51,250
2.
South African R=$50,000*7=$350,000
Future Value=Investment(1+r)n=R350,000*(1+0.06/2)=R350,000*1.03=R360,500
3.
Equivalent amount in $ if Exchange rate is (1$=R7.125)
Equivalent amount =R360,500/R7.125=$50,596.49
4.
forward rate would cause you to be indifferent between investing your money in U.S. securities versus investing in S.A
1$=R7
1$*(1.025)=R7*1.03
1.025 $=R7.21
1$=R7.21/1.025=R7.03415
1$=R7.03415
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