In: Finance
2. Given a spot exchange rate quote for USD/CHF at 1.6627 and a 6-month forward quote for USD/CHF at 1.6558, and 6-month interest rates for USD at 3.5%/year and for CHF at 3.0%/year, is interest rate parity holding? If there is an arbitrage opportunity, what steps would be needed to execute the trade, and what would be the expected profit given $1M notional?
Forward rate= USD per CHF * (1+Interest rate in USD)/(1+Interest rate in Swiss) | |||
Forward rate= | =1.6627*(1+0.035)/(1+0.03) | ||
Per CHF | $ 1.6708 | ||
Since given forward rate is 1.6558, we can see that some arbitrage opportunity is available | |||
Since USD is getting stronger, it is better to invest in USD. | |||
If the amount is invested in CHF | |||
Equivalent CHF | 1000000/1.6627 | ||
Equivalent CHF | 601,431 | ||
Investment value after 6 montsh | =601431*(1+3%) | ||
619,474 | |||
Amount converted back to USD | 619474*1.6558 | ||
Amount converted back to USD | 1,025,726 | ||
If funds are invested in USD so amount after 6 months | =1000000*(1+3.5%) | ||
$ 1,035,000 | |||
So this way there will be gain if invested in US | $ 9,274.37 | 1035000-1025726 |