Suppose that the current spot rate is €0.80/$ and the 3-month forward exchange rate is €0.7813/$....

Suppose that the current spot rate is €0.80/$ and the 3-month forward exchange rate is €0.7813/$. The 3-month interest rate is 4.6% per annum in the U.S. and 4.4% per annum in France. Assume that you can borrow up to $1,000,000 or €800,000. Show how to realize a certain profit without taking any risk, assuming that you want to realize profit in terms of $. Also determine the size of your profit.

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Expert Solution

Ans :

Borrow 1000000 dollars
Convert to 800000 euros
Invest in UK becomes

800000*(1+4.4%*3/12)=808800 euros or 808800/0.7813=1035197.75 dollars

Return 1000000*(1+4.6%*3/12)=1011500 dollars

Profit = 1035197.75 - 1011500 = 23697.75

jeff jeffy answered 1 year ago

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