Camar Automotive Hoist

Integrative Problem--P264

Date: Nov. 14th

Exchange Rate Behavior

Questions

1. Triangular Arbitrage:

Ј = $1.596

A$ = $0.70

Cross exchange rate: Ј = A$2.28

Cross interest rate should be: Ј = $1.596/$0.70 = A$ 2.28

Triangular arbitrage capitalizes on discrepancies in cross exchange rates.

There are no discrepancies in cross exchange rates. Therefore, triangular arbitrage is not feasible in this situation.

2. Covered Interest Arbitrage:

British pound:

Spot rate: Ј = $1.596

Forward rate: Ј = $1.58004

U.S interest rate: iU.S. = 8.00%

British interest rate: iBritish =9.09%

(F-S)/S = ($1.58004-$1.596)/ $1.596 = -1%

ih - if = 8%-9.09% = -1%

We get: (F-S)/S = ih - if

Covered interest arbitrage capitalizes on discrepancies between the forward rate and the interest rate differential.

(F-S)/S = ih - if, therefore, covered interest arbitrage is not feasible on British pound.

Australian dollars:

Spot rate: A$ = $0.70

Forward rate: A$ = $0.71

U.S interest rate: iU.S. = 8.00%

Australian interest rate: iAustralian =7.00%

(F-S)/S = ($0.71-$0.70)/ $0.70 = 1.4%

ih - if = 8%-7.00% = 1%

We get: (F-S)/S ≠ ih - if

Therefore, covered interest arbitrage is feasible on Australian dollars.

Conduct:

Suppose we have A$1,000,

Activity Amount

1. Use Australian dollars to purchase U.S. dollars in the spot market, at A$ = $0.70. A$1,000=A$*0.70=$700

2.