Business, 19.10.2020 18:01 perez120

An American currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate is i$ = 2% in the U. S. and i€ = 6% in the euro zone, respectively. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how you can realize a certain dollar profit via covered interest arbitrage. a. Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€= 6%;translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Gross proceeds will be $1,017,600.
b. Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€= 6%;translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Net profit will be $17,600.
c. Borrow €800,000 at i€= 6%;translate euros to dollars at the spot rate, invest dollars in the U. S. at i$ = 2% for one year; translate dollars back to €850,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000.
d. Borrow €800,000 at i€= 6%;translate euros to dollars at the spot rate, invest dollars in the U. S. at i$ = 2% for one year; translate dollars back to €848,000 at the forward rate of $1.20 = €1.00. Net profit will be $2,400.

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An American currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one yea...

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