Question

In: Finance

The spot rate between Canada and the U.S. is Can$1.2449/$, while the one-

The spot rate between Canada and the U.S. is Can$1.2449/$, while the one-year forward rate is Can$1.2448/$. The risk-free rate in Canada is 4.65 percent and risk-free rate in the United States is 2.77 percent. How much in profit can you earn on $12,500 utilizing covered interest arbitrage?

Expert Solution

Borrow in USD, convert to Can$ at the spot rate, invest in Can$, reconvert to USD at the forwards rate and finally repay the USD loan.

Amount in Can$ = Amount in USD*Exchange rate of Can$ per USD

= 12500*1.2449

= Can$15,561.25

Maturity value of investment in Canada = Investment*(1+ Interest ratain Can$)

=15561.25*(1+0.0465)

= Can$16,284.85

Amount in US$ on reconversion = Maturity value in Can$/Forward rate

=16284.85/1.2448

= $13,082.30

Repayment in US $ at 2.77% interest rate after 1 year = 12500*1.0277

= $12,846.25

Profit = Amount in USD after reconversion- Repayment of USD loan

=13082.30-12846.25

= $236.05

Profit = $236.05

Junaid answered 1 year ago

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