Assume that annual interest rates are 5 percent in the United States and 4 perce
ID: 2781438 • Letter: A
Question
Assume that annual interest rates are 5 percent in the United States and 4 percent in Turkey. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is $0.6647/Turkish lira (TL).
If the forward rate is $0.6735/TL, how could the bank arbitrage using a sum of $8 million? What is the spread earned? (Do not round intermediate calculations. Round your answer to 4 decimal places. (e.g., 32.1616))
Assume that annual interest rates are 5 percent in the United States and 4 percent in Turkey. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is $0.6647/Turkish lira (TL).
Explanation / Answer
Today borrow $ 8 million in US,so payment after one year ,8(1+.05) = $ 8.4million or 8,400,000
Invest 8 million borrowed in Turkey,
Amount invested in TL : 8,000,000/.6647 = TL 12035504.7389
Amount after one year: 12035504.7389(1+.04)=12516924.9284
Amount in US dollars after one year : 12,516,924.9284*.6735 = $ 8,430,148.9393
spread = Amount earned -Amount paid
= 8,430,148.9393- 8,400,000
= $ 30,148.9393
spread % =spread /amount invested
= 30148.9393/8,000,000
= .003769 or .3769%