Question

1. Your U.S. company has $20,000,000 to be invested for the next 270 days. Using only the data given below, answer the following questions. (a and b).

_____________________________________________________________________________________

U.S. interest rate (annual): 6%

Japanese interest rate (annual): 6%

Spot rate:                                            Yen 204 per U.S. Dollar

270 day forward rate: Yen 202 per U.S. Dollar

Your forecast of the spot rate                   

In 270 days:                                         Yen 207 per U.S. dollar

a.) In which country would you invest the $20,000,000 if you had the ability to use the forward market? What total amount (in dollars) would you obtain at the end of 270 days? Show the necessary calculations.

b.) In which country would you invest the $20,000,000 if you are 100% certain that the forecast will come true? What total amount (in dollars) would you obtain at the end of 270 days? Show the necessary calculations.

2. As locational arbitrage occurs due to the following bid and ask rates of the pound for two banks shown below, what actions will result?

	Bid	Ask
Bank A	$1.41	$1.42
Bank B	$1.39	$1.40

Select one:

a. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will increase.

b. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will decrease.

c. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will decrease.

d. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase.

Answer 1

a. Future Value if Money Invested in US Dollar = Investment * (1 + 270 day Interest) = 20000000 * 1.045 = $20900000

Future Value if Money invested in Yen = Investment * Exchange Rate * (1 + 270 day Interest) / Forward Rate

Future Value if Money invested in Yen = 20000000 * 204 * 1.045 / 202

Future Value if Money invested in Yen = $21106931.69

If the Forward Rates are Available then the Investing in Japan is beneficial as its future value is highest

b. Future Value if Money Invested in US Dollar = Investment * (1 + 270 day Interest) = 20000000 * 1.045 = $20900000

Future Value if Money invested in Yen = Investment * Exchange Rate * (1 + 270 day Interest) / Future Spot Rate

Future Value if Money invested in Yen = 20000000 * 204 * 1.045 / 207

Future Value if Money invested in Yen = $20597101.45

with 100% certainity of Future rate, Investing in US is beneficial as its future value is highest

2.

An arbitrage involves buying at low rate and selling at high rate

In Our Case Bank B is offering Pound at $1.40 and Bank A is buying pound at $1.41 thus an arbitrage involves buying at Bank B and Selling to Bank A which result in offer price to increase and buy price to decrease  

d. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase.

Please dont forget to upvote