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How much arbitrage profit can you obtain with the following information? Hint. Covered interest arbitrage Spot...

How much arbitrage profit can you obtain with the following information? Hint. Covered interest arbitrage Spot exchange rate: 1.1 Euro / dollar Forward exchange rate: 1 Euro / dollar Risk free rate in U.S: 3% Risk free rate in Europe: 2%

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Expert Solution

Forward rate= EURO per USD * (1+Interest rate in EURO)/(1+Interest rate in USA)
Forward rate= =1.1*(1+0.02)/(1+0.03)
Per USD                  1.09
Since given forward rate is 1.00, we can see that some arbitrage opportunity is available
So the funds available are invested in EURO
Loan taken in USD $        100,000
Equivelent EURO =100000*1.1
€        110,000
This is invested in EURO so amount after 12 months =110000*(1+2%)
€        112,200
Amount converted back to USD =112,200/1
$        112,200
Amount payable in US after 12 months for loan =100000*(1+3%)
$        103,000
So this way there will be gain 112200-103000
So this way there will be gain $            9,200

jeff jeffy answered 1 year ago
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