Question

Assume the following information:Spot rate today of Swiss franc = $.60 1-year forward rate as of today for Swiss franc = $.63 Expected spot rate 1 year from now = $.64 Rate on 1 year deposits denominated in Swiss francs = 7% Rate on 1 year deposits denominated in U.S. dollars = 9% From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of _______%.

Answer 1

Answer:

12.35%

Explanation:

Data provided in the question:

Spot rate today of Swiss franc = $0.60

1-year forward rate as of today for Swiss franc = $0.63

Expected spot rate 1 year from now = $0.64

Rate on 1 year deposits denominated in Swiss francs = 7%

Rate on 1 year deposits denominated in U.S. dollars = 9%

Amount invested = $1,000,000

Now,

Amount with Swiss franc = Amount invested ÷ Spot rate today of Swiss franc

= $1,000,000 ÷ 0.60

= $1,666,666.67

After 1 year = $1,666,666.67 × ( 1 + 0.07)

= $1,783,333.33

1 year Forward value = $1,783,333.33 × 0.63

= $1123499.99

Therefore,

Yield = [ $1123499.99 - $1,000,000 ] ÷ $1,000,000

= 0.1235

or

= 0.1235 × 100%

= 12.35%