Question

In: Accounting

The one year interest rates in Australia and US are 3% and 1%, respectively. The current...

The one year interest rates in Australia and US are 3% and 1%, respectively. The current spot rate is $0.75/AUD. (Show calculation and steps)

a. What should the one year forward rate be (if IRP holds).

b. If the forward rate is $0.70/AUD is there an arbitrage? If so, how can an arbitrageur incorporate a cashless (i.e. not use any of her current cash) arbitrage? Hint: She will need to borrow in the US or Australia at the current rates. Assume that she will use an amount of 1,000,000 USD or AUD (you must choose the right one…)

Expert Solution

Answer:

Interest rate of Australia is 3 %

Interest rate of US is 1 %

Spot rate is $ 0.75 / AUD

1 Year forward rate = Spot rate x (1 + Rate of US) / 1 + rate of Australia)

= $ 0.75 x (1+1 %) / (1 + 3%)

= $ 0.75 x 0.33

= 0.248

givef forward rate = $ 0..70 / AUD

Therefore there is an arbitrage opportunity

Borrowed USD 1,000,000

Interest to to be paid @ 1% 10,000

Total amount will be returned after 1 year 1010,000

Conversion of USD to AUD @ spot rate of 0.75 = 1,333,333.33

Invest in Australia @ 3% = 39, 999.99

Total amount after 1 year = 1,373,333.32

Conversion of USD @ give rate is 0.7 = 96133.32

Amount to be paid = 1010000

Arbitrage - 1106133.32

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ekkarill92 answered 2 months ago

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