Business, 07.11.2019 06:31 evanwall91

)a currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. the one-year interest rate in the u. s. is i$ = 5% and in the euro zone the one-year interest rate is i€ = 4%. the spot exchange rate is $1.25/€ and the one-year forward exchange rate is $1.40/€. a.) show how to realize a certain profit via covered interest arbitrage.

a) borrow $1,000,000 at 2%. trade $1,000,000 for €800,000; invest at i_€=6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600

b) borrow €800,000 at i_€=6%. translate to dollars at the spot, invest in the u. s at i_$=2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00 net profit $2400

c) borrow €800,000 at i_€=6%. translate to dollars at the spot, invest in the u. s at i_$=2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00 net profit $2000

d) both c and b.

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