Question

Casper​ Landsten-UIA (B). Casper Landsten is a foreign exchange trader for a bank in New York. Using the values and assumptions​ below, he decides to seek the full 4.798 return available in U.S. dollars by not covering his forward dollar receipts —an uncovered interest arbitrage​ (UIA) transaction. Assess this decision.

Arbitrage funds available	$	1,100,000
Spot exchange rate (SFr/$)		1.2809
3-month forward rate (SFr/$)		1.2744
Expected spot rate in 90 days (SFr/$)		1.2704
U.S. Dollar annual interest rate		4.798	%
Swiss franc annualinterest rate		3.198	%

The uncovered interest arbitrage​ (UIA) profit amount is ___ (Round to the nearest​ cent.)

Answer 1

Let's see how can Casper utilize arbitrage opportunity to his advantange:

The first requirement is as this is a 3-month forward rate, we need to divide the annual interest rate by 3 and divide by 12.

Now lets see the first scenario when Casper invests his USD only (by not converting it into SFr). This way he will get return of 1.1995% on his invested amount (i.e. $13,194.50)

Now, lets see another scenario when Casper first converts his USD into SFr. So, for $1,100,000 he will get = $1,100,000 x 1.2809 = SFr 1,408,990

Now, he invests this SFr @ 0.7995 for three months:

Now, he will turn his total SFr 1,420,254.88 in the 3 month @ 1.2704 per USD. So Total USD he will get is = 1,420,254.88 / 1.2704 = $1,117,958.82.

So, total interest would be $1,117,958.82 - $1,100,000 = $17,958.82.

So, definitely arbitrage (converting USD into SFr and investing) would give more result as compared with investing USD directly.