Question

In: Finance

You can currently borrow or invest in the US at 2% and you can borrow or...

You can currently borrow or invest in the US at 2% and you can borrow or invest in Japan at 3%. The current exchange rate is $0.01/Yen. Inflation rate in the US is expected to be 5% and expected to be 1% in Japan. If the exchange rates will have adjusted to differences in inflation by the end of one year, show how these numbers will allow you to make profit. Be Specific. Show the profit you would make at the end of the year if you started by borrowing EITHER (choose one) $1 million or 1 million Yen today. Please show all work and do not use excel or a finance calculator.

Solutions

Expert Solution

$ Yen
Borrowing/Deposit Rate 2% 3%
Inflation Rate 5% 1%
Amount available $ 1 Million
Spot Rate $0.01/Yen
1 Year Forward Rate $0.0104/Yen
As per Purchasing Power Parity Theorem,
Forward Exchange Rate$ = Spot$ ( 1 + I$) / ( 1 + IYen)
Forward Exchange Rate$ = 0.01 ( 1 + 0.05) / ( 1 + 0.01)
Forward Exchange Rate$ = 0.0104
As per the Interst rates prevailing:
Fair Forward Exchange Rate$ = 0.01 ( 1 + 0.02) / ( 1 + 0.03)
Fair Forward Exchange Rate$ = 0.0099
a Borrow $ 1 Million
b Convert to Yen, We receive $ 1 Million / $ 0.01 = Yen 100,000,000
c Deposit Yen received for 1 Year
Amount Recieved in Yen after 1 year = $ 100,000,000 (1+0.03)
Amount Recieved in Yen after 1 year = $ 103,000,000
d Reconvert the Amount received in Yen to $
We will receive, $ 103,000,000 / $ 0.0104 = 1,071,200
e Amunt required for repayment of Amount Borrowed = $ 1,000,000 (1+0.02)
Amunt required for repayment of Amount Borrowed = $ 1,020,000
f Arbitrage Profit = d - e
Arbitrage Profit = $ 1,071,200 - $ $1,020,000
Arbitrage Profit = $ 51,200

Related Solutions

Question 1 You currently have $7,500 to invest. You can invest the full amount now for...
Question 1 You currently have $7,500 to invest. You can invest the full amount now for a period of 9 years at which time you want to have $15,000. Approximately what rate of return is needed to accomplish this investment goal? 8.01% 7.59% 9.65% 8.50% Question 2 If four years of college tuition cost $15,000 in 1990, what did it cost in 1965 if tuition increased at 7% per year between 1965 and 1990? $2,764 $1,405 $3,876 $8,141 Question 3...
An investor can borrow or invest at a risk-free rate of 4%. The investor is a...
An investor can borrow or invest at a risk-free rate of 4%. The investor is a mean-variance utility maximize with a risk aversion coefficient A = 4. What is the expected return on an optimal allocation between the risk-free security and a risky portfolio with an expected return of 10% and a volatility of 20%?
Q2: Suppose a US investor has $4000 to invest and can choose either a US investment...
Q2: Suppose a US investor has $4000 to invest and can choose either a US investment paying 2% or a foreign investment paying 4%, where e is currently 1.14 and the investor can lock in e in one year equal to 1.16. Q2a- How much will the US investment be worth after a year? q2b- How much foreign currency can investor get now? Q2c- How much foreign currency will investor get after a year? Q2d-How much (in dollars) will the...
Suppose a US investor has $11900 to invest and can choose either a US investment paying...
Suppose a US investor has $11900 to invest and can choose either a US investment paying 2.25% or a foreign investment paying 12%, where e is currently 32. What future e would leave the investor indifferent between investing at home or abroad?
Meyer & Co. currently has no debt, but it can borrow at 8 percent. The firm...
Meyer & Co. currently has no debt, but it can borrow at 8 percent. The firm value is $415,000, and its cost of equity is 13 percent. The tax rate is 35 percent. a. What will be the firm value if Meyer & Co. borrows $125,000 and uses the proceeds to repurchase shares? b. What is the cost of equity after recapitalization? c. What is the WACC after recapitalization?
Braxton Corp. has no debt but can borrow at 6.4 percent. The firm’s WACC is currently...
Braxton Corp. has no debt but can borrow at 6.4 percent. The firm’s WACC is currently 8.2 percent, and the tax rate is 35 percent. a. What is the company’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity % b. If the firm converts to 35 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as...
Shadow Corp. has no debt but can borrow at 7.1 percent. The firm’s WACC is currently...
Shadow Corp. has no debt but can borrow at 7.1 percent. The firm’s WACC is currently 8.9 percent, and the tax rate is 35 percent. a. What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Calculate the Cost of equity % b. If the company converts to 25 percent debt, what will its cost of equity be? (Do not round intermediate calculations and...
Shadow Corp. has no debt but can borrow at 6.3 percent. The firm’s WACC is currently...
Shadow Corp. has no debt but can borrow at 6.3 percent. The firm’s WACC is currently 8.1 percent, and the tax rate is 35 percent. a. What is the firm’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity            % b. If the firm converts to 30 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your...
Legacy Co. has no debt but can borrow at 7%. The firm’s WACC is currently 11%,...
Legacy Co. has no debt but can borrow at 7%. The firm’s WACC is currently 11%, and the tax rate is 35%. a. What is Legacy Co.'s cost of equity? b. If the firm converts to 25% debt, what will its cost of equity be? c. If the firm converts to 50% debt, what will its cost of equity be? d. What is Legacy Co.'s WAACC in part (b)? In part (c)?
Shadow Corp. has no debt but can borrow at 6.7 percent. The firm’s WACC is currently...
Shadow Corp. has no debt but can borrow at 6.7 percent. The firm’s WACC is currently 8.9 percent and the tax rate is 25 percent. a. What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If the firm converts to 40 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT