3.A Assume that today is 21 March 2019. Today, you observe that the exchange rate between...

Free

70.2K

Verified Solution

Question

Finance

3.A Assume that today is 21 March 2019. Today, you observe thatthe exchange rate between AU$ and the US$ is 1.319, EAU$/US$=1.319,the 90-day interest rate in Australia is 0.50%, the 90-day interestrate in the US is 0.22%, and the 90-day forward rate is 1.376,FAU$/US$=1.376. Note that the covered interest parity does not holdhere. Explain how you can make risk free profits using spot andforward markets in 90 days, on 20 May 2019, if you can eitherborrow AU$1.319 million Australian dollars or borrow US$1 milliondollars with the interest rates above today. The answer should havethe exact amount of profits in Australian dollars. Hint: outlineall investment steps and show all calculations. Do not forget topay the principal and interests on 20 May 2019. [6 marks]
3.B. Using diagrams explain what will happen to the current spotexchange rate (increase, decrease, or no change) if the forwardrate in (A) and the nominal interest rates in two countries remainthe same (the answer should have the change in the demand for orthe supply of euros in the foreign exchange market and also thevalue of the for new exchange rate).

Answer & Explanation Solved by verified expert

3.6 Ratings (457 Votes)


Forward Rate should be :
1.3191.005AUD=11.0022US$
1.322685AUD/1US$
Current Forward Rate :1.376AUD/US$
Profit can be made by selling USD in forward
STEP1 SELL USD( 1 *1.0022)million in forward
STEP 2: Borrow 1.319million AUD at interest rate 0.5% for 90 days
STEP3: Convert AUD to USd at current spot rate=1.319AUD/US$
Amount of USD received =1 million
STEP4 :Invest 1million USD at 0.22% for 90 days
STEP 5: Amount received in USD after 90 days=1million*1.0022	1,002,200	USD
STEP6:Amount of AUD to be received =(1.0022*1.376)	1,379,027.20	AUD
STEP7:Pay back Borrowed AUD along with interrest of 0.5%
Amount Payable in AUD for borrowing in step 2=(1.319*1.005) million	1,325,595.00	AUD
Amount of Profit in Australian Dollars=(1379027.20-325595.00)=	53,432.20	AUD

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

3.A Assume that today is 21 March 2019. Today, you observe thatthe exchange rate between AU$ and the US$ is 1.319, EAU$/US$=1.319,the 90-day interest rate in Australia is 0.50%, the 90-day interestrate in the US is 0.22%, and the 90-day forward rate is 1.376,FAU$/US$=1.376. Note that the covered interest parity does not holdhere. Explain how you can make risk free profits using spot andforward markets in 90 days, on 20 May 2019, if you can eitherborrow AU$1.319 million Australian dollars or borrow US$1 milliondollars with the interest rates above today. The answer should havethe exact amount of profits in Australian dollars. Hint: outlineall investment steps and show all calculations. Do not forget topay the principal and interests on 20 May 2019. [6 marks]3.B. Using diagrams explain what will happen to the current spotexchange rate (increase, decrease, or no change) if the forwardrate in (A) and the nominal interest rates in two countries remainthe same (the answer should have the change in the demand for orthe supply of euros in the foreign exchange market and also thevalue of the for new exchange rate).