Currently, the spot exchange rate is $0.84 per A$ and the one-year forward exchange rate is $0.80 per A$. One-year interest is 3.5% in the United States and 4.2% in Australia. You may borrow up to $1,000,000 or A$1,190,476, which is equivalent to $1,000,000 at the current spot rate. Required: Determine if IRP is holding between Australia and the United States. If IRP is not holding, explain in detail how you would realize certain profit in U.S. dollar terms. What will be your arbitrage profit? Explain how IRP will be restored as a result of arbitrage transactions you carry out above.

Currently, the spot exchange rate is $0.84 per A$ and the one-year forward exchange rate is $0.80 per A$. One-year interest is 3.5% in the United States and 4.2% in Australia. You may borrow up to $1,000,000 or A$1,190,476, which is equivalent to $1,000,000 at the current spot rate. Required: Determine if IRP is holding between Australia and the United States. If IRP is not holding, explain in detail how you would realize certain profit in U.S. dollar terms. What will be your arbitrage profit? Explain how IRP will be restored as a result of arbitrage transactions you carry out above.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter27: Multinational Financial Management

Section: Chapter Questions

Problem 7MC

See similar textbooks

Required:

Determine if IRP is holding between Australia and the United States.
If IRP is not holding, explain in detail how you would realize certain profit in U.S. dollar terms. What will be your arbitrage profit?
Explain how IRP will be restored as a result of arbitrage transactions you carry out above.

Expert Solution

This question has been solved!

Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.

This is a popular solution!

SEE SOLUTION Check out a sample Q&A here

Step 1: Given:

VIEW

Step 2: 1. Determine whether IRP holds good:

VIEW

Step 3: 2. Calculate Arbitrage Profit in dollar terms:

VIEW

Step 4: 3. Restoration of IRP:

VIEW

Solution

VIEW

Trending now

This is a popular solution!

Step by step

Solved in 5 steps with 4 images

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.

Similar questions

Currently, the spot exchange rate is $1.59 per £ and the three-month forward exchange rate is $1.61 per £. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,590,000 or £1,000,000. Required: Determine whether the interest rate parity is currently holding. If the IRP is not holding, how would you carry out covered interest arbitrage? What will be your arbitrage profit? Explain how the IRP will be restored as a result of covered arbitrage activities.
Currently, the spot exchange rate is $1.51 per £ and the three-month forward exchange rate is $1.53 per £. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,510,000 or £1,000,000. Required: a. Determine whether the interest rate parity is currently holding. b. If the IRP is not holding, how would you carry out covered interest arbitrage? What will be your arbitrage profit? c. Explain how the IRP will be restored as a result of covered arbitrage activities. Complete this question by entering your answers in the tabs below. Required A Required B Required C If the IRP is not holding, how would you carry out covered interest arbitrage? What will be your arbitrage profit? Note: Do not round intermediate calculations. Interest arbitrage Arbitrage profit Borrow in the U.S. and invest in the U.K. Hedge exchange rate risk by selling British pounds forward. < Required A Required C
Currently, the spot exchange rate is $1.67 per £ and the three-month forward exchange rate is $1.69 per £. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,670,000 or £1,000,000. Required: a. Determine whether the interest rate parity is currently holding. b. If the IRP is not holding, how would you carry out covered interest arbitrage? What will be your arbitrage profit? c. Explain how the IRP will be restored as a result of covered arbitrage activities. Complete this question by entering your answers in the tabs below. Required A Required B Required C Determine whether the interest rate parity is currently holding. Determine whether the interest rate parity is currently holding.
Currently, the spot exchange rate is CHF 0.89/$ and the three-month forward exchange rate is CHF 0.86/$. The three-month interest rate is 5.6% per annum in the U.S. and 4.0% per annum in Switzerland. Assume that you can borrow as much as $1,120,000 or CHF 1,000,000. Determine whether the interest rate parity is currently holding. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. Explain how the IRP will be restored as a result of covered arbitrage activities.
Currently, the spot exchange rate is CHF 0.89/$ and the three-month forward exchange rate is CHF 0.86/$. The three-month interest rate is 5.6% per annum in the U.S. and 4.0% per annum in Switzerland. Assume that you can borrow as much as $1,120,000 or CHF 1,000,000. A. Determine whether the interest rate parity is currently holding. B. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. C. Explain how the IRP will be restored as a result of covered arbitrage activities.
Suppose that the current spot exchange rate is €0.85 per $ and the three-month forward exchange rate is €0.8313 per $. The three- month interest rate is 5.60 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1,000,000 or €850,000. Required: a. How will you realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars? What will be the size of your arbitrage profit? b. Assume that you want to realize profit in terms of euros. Show the covered arbitrage process and determine the arbitrage profit in euros. How will you realize a certain profit and size of your arbitrage profit? Complete this question by entering your answers in the tabs below. Required A Required B How will you realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars? What will be the size of your arbitrage profit? Note: Do not round…
Suppose that the current spot exchange rate is €0.80/$ and the three-month forward exchange rate is €0.7813/$. The three-month interest rate is 5.60 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1,000,000 or €800,000. a. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit. b. Assume that you want to realize profit in terms of euros. Show the covered arbitrage process and determine the arbitrage profit in euros. 2. ATech has fixed costs of $7 million and profits of $4 million. Its competitor, ZTech, is roughly the same size and this year earned the same profits, $4 million. But it operates with fixed costs of $5 million and lower variable costs. a. Which firm has higher operating leverage? Hint: Use Degree of Operating Leverage (DOL), b. Which firm will likely have higher profits if the…
Suppose that the current spot exchange rate is €0.80/$ and the three-month forward exchange rate is €0.7813/$. The three-month interest rate is 5.60% per annum in the United States and 5.40% per annum in France. Assume that you can borrow $1,000,000. How much can you realize via covered interest arbitrage? €10,800. $23,758. €37,757. $7,813. $37,757. $14,000.
Suppose that the current spot exchange rate is €0.830/S and the three-month forward exchange rate is €o.815/S. The three-month interest rate is 6.00 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1,000,000 or €830,000. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit.
Suppose that the current spot exchange rate is €1.72 per £ and the one-year forward exchange rate is €1.80 per £. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, i.e., £581,395, at the current spot exchange rate. Required: a. If you are a euro-based investor, how can you realize a guaranteed profit from covered interest arbitrage and the size of arbitrage profit? b. How will the interest rate parity be restored as a result of the above transactions? c. If you are a pound-based investor, what is the covered arbitrage process and the size of the arbitrage profit? Complete this question by entering your answers in the tabs below. Required A Required B Required C If you are a euro-based investor, how can you realize a guaranteed profit from covered interest arbitrage and the size of arbitrage profit? Note: Do not round intermediate calculations. Round off the final answer to nearest whole dollar. Profit from…
You are given the following information:Spot exchange rate (AUD/EUR) 1.60One-year forward rate (AUD/EUR) 1.62One-year interest rate on the Australian dollar 8.5%One-year interest rate on the euro 6.5%(a) Is there any violation of CIP?(b) Calculate the covered margin (going short on the AUD).(c) Calculate the interest parity forward rate and compare it with the actual forward rate.
Currently, the spot exchange rate is $0.80/A$ and the one-year forward exchange rate is $0.76/A$. One-year interest is 3.5% in the United States and 4.2% in Australia. You may borrow up to $1,000,000 or A$1,250,000, which is equivalent to $1,000,000 at the current spot rate. Determine if IRP is holding between Australia and the United States. Yes O No