Problem 18-7 Interest Rates and Arbitrage [L0 2 The treasurer of a major U.S. fi
ID: 2617783 • Letter: P
Question
Problem 18-7 Interest Rates and Arbitrage [L0 2 The treasurer of a major U.S. firm has $32 million to invest for three months. The interest rate in the United States is 49 percent per month. The interest rate in Great Britain is .53 percent per month. The spot exchange rate is £.70, and the three-month forward rate is £.71. Ignore transactions costs. (Enter your answer as directed, but do not round intermediate calculations.) Requirement 1: (a) If the treasurer invested the company's funds in the U.S., how much would the investment be worth after three months? (Enter your answer in dollars, not millions of dollars (e.g.. 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).) unt (b) If the treasurer invested the company's funds in Great Britain, how much would the investment be worth after three months in U.S. dollars? (Enter your answer in dollars, not millions of dollars (e.g 1,234,567). Round your answer to 2 decimal places (e.g. 32.16)) Amount Requirement 2: In which country would the treasurer want to invest the company's funds? United StatesExplanation / Answer
Requirement 1
a) The investment in US will earn 0.49% per month for 3 months -
Value of Investment after 3 months = Investment + Interest
or, Value of Investment after 3 months = $32,000,000 + ($32,000,000 x 0.49% x 3) = $32,470,400.00
b) For investing in Great Britain, we would have to convert the investment in pounds and then invest it @0.53% for 3 months.
Investment value in pounds = $32,000,000 x Pound 0.70 per dollar = Pounds 22,400,000
Investment value in pounds after 3 months = Pounds 22,400,000 + Pounds 22,400,000 x 0.53% x 3 = Pounds 22,756,160
Investment value in dollars = Pounds 22,756,160 / Pound 0.71 per dollar = $32,050,929.58
Requirement 2
The Treasurer will want to invest in United States as the investment value is more in that case.