Question

In: Finance

2. Given a spot exchange rate quote for USD/CHF at 1.6627 and a 6-month forward quote...

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?

Solutions

Expert Solution

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

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