Interest Rate Parity (25 p) Assume you are a Turkish investor who has the headquarter in...

Interest Rate Parity (25 p)

Assume you are a Turkish investor who has the headquarter in Istanbul. Currently, you have not sufficient capital for investment. However, you intend to operate with 1.000.000 Turkish Lira (TL) that will be provided by a domestic bank. Given the information in Table 3 elaborate an arbitrage strategy to achieve some riskless profit. How much is your riskless profit from your strategy? Is it worth to undertake the strategy?

Table 3.

Spot Rate of 1 USD (S)	3,900
Forward Rate of 1 USD (F)	4,120
Interest rate on USD Deposits (r)	0,089
Interest rate on TL Deposits (r)	0,150

Solutions

Expert Solution

Borrow 1000000 Turkish Lira(TL) and buy USD.Invest these USD @8.9%.Convert the amount invested plus interest using forward rate.Repay the TL borrowing using the converted amount

Calculation of Arbitrage profit

Spot rate of 1$	3900
Forward rate of 1$	4120
% of premium	(4120-3900)/3900 = 5.6410

Borrow TL 1000000 @ 15%	TL 1000000
Convert TL 1000000 to USD using spot rate	1000000/3900	256.4103

Invest USD 256.4103 @ 8.9%	Interest	22.82051
Total	279.2308

Sell USD using forward rate	279.2308*4120
	1150430.769
Repay the borrowing with interest
Borrowing 1000000 TL
Add:Interest payable @ 15% 150000TL
1150000	1150000
Arbitrage gain in TL	430.7692308

It is worth undertaking this strategy since the profit is 430.769

ekkarill92 answered 1 year ago

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