Question
In: Finance
Assume the following information: 1-year interest rate on U.S. dollars = 11.5% 1-year interest rate on...
Assume the following information: 1-year interest rate on U.S. dollars = 11.5% 1-year interest rate on Singapore dollars = 9.7% Spot rate of Singapore dollar = 0.48 USD/SGD 1-year forward premium on Singapore dollars = 3.64% Given this information, how much profit can be made with covered interest arbitrage, by borrowing 1 million USD?
Solutions
Expert Solution
You would use the following steps for covered interest arbitrage -
Step 1 - borrow 1 million USD @11.5% and convert the same into SGD using the spot rate
Amount of SGD received = USD 1,000,000 / USD 0.48 / SGD = SGD 2,083,333.3333
Step 2 - Invest this amount in singapore @9.7%
Amount received after 1 year = SGD 2,083,333.3333 + 9.7% x SGD 2,083,333.3333 = SGD 2,285,416.6667
Step 3 - Convert the above SGD into USD using future spot rate and repay the loan
Expected spot rate = USD 0.48 + 3.64% = USD 0.4975 / SGD [Their is a premium on singapore dollars, i.e., SGD will appreciate in the future. Therefore, you would be able to buy more USD for 1 SGD.]
Amount received in USD = SGD 2,285,416.6667 x USD 0.4975 / SGD = USD 1,136,994.7917
Amount of loan plus interest payable = USD 1,000,000 + 11.5% x USD 1,000,000 = USD 1,115,000
Covered interest arbitrage = USD 1,136,994.7917 - USD 1,115,000 = USD 21,994.7917 or USD 21,994.79
jeff jeffy answered 1 year agoRelated Solutions
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