Toshi Numata, FX analyst at Credit Suisse (Tokyo), observes that the ¥/$ spot rate has been...

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Finance

Toshi Numata, FX analyst at Credit Suisse (Tokyo), observes thatthe ¥/$ spot rate has been holding steady, and both U.S. dollar andyen interest rates have remained relatively fixed over the past fewweeks. Toshi wonders if he should try an interest arbitragestrategy. Toshi's research associates — and their prediction models— are predicting the spot rate to move to ¥100.00/$ 90 days fromtoday. Assume each year has 360 days and the interest rate forshort loans is priced using the simple interest rate method.
Table 2. – Use for Questions a) to c)
Assumptions Value
Arbitrage funds available (¥) YEN 80,000,000
Equivalent arbitrage funds available ($) USD 1,000,000
Spot rate (¥/$) 80.00
90-day forward rate (¥/$) 90.00
180-day forward rate (¥/$) 95.00
U.S. dollar LIBOR rate p.a. for the next 180 days 2.000%
Japanese yen LIBOR rate p.a. for the next 180 days0.000%
a) Calculate the expected gain in $ from an Uncovered InterestArbitrage (UIA) strategy using the expected spot rate in 90 dayspredicted by Toshi’s research associates.
b) The actual spot rate 90 days from today turned out to be72.00(¥/$) instead of 100 (¥/$) as predicted. Discuss how Toshi’sinterest arbitrage strategy in question a) is affected.
c) Discuss how a Covered Interest Arbitrage strategy isdifferent from an Uncovered Interest Arbitrage strategy.

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Part a Arbitrage funds available FYen YEN 80000000 Equivalent arbitrage funds available F USD 1000000 Current Spot rate S0 8000 Expected spot rate after 90 days S1 10000 We invest F at interest rate i 2000 for 90 days to get the maturity proceed F maturity F x 1 i x n 360 1000000 x 1 2 x n 360 1000000 x 1 2 x 90 360 1005000 If FYen is invested at Yen interest rate iYen 0000 for 90 days to get the maturity proceed FYen maturity FYen See Answer

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Toshi Numata, FX analyst at Credit Suisse (Tokyo), observes thatthe ¥/$ spot rate has been holding steady, and both U.S. dollar andyen interest rates have remained relatively fixed over the past fewweeks. Toshi wonders if he should try an interest arbitragestrategy. Toshi's research associates — and their prediction models— are predicting the spot rate to move to ¥100.00/$ 90 days fromtoday. Assume each year has 360 days and the interest rate forshort loans is priced using the simple interest rate method.Table 2. – Use for Questions a) to c)Assumptions ValueArbitrage funds available (¥) YEN 80,000,000Equivalent arbitrage funds available ($) USD 1,000,000Spot rate (¥/$) 80.0090-day forward rate (¥/$) 90.00180-day forward rate (¥/$) 95.00U.S. dollar LIBOR rate p.a. for the next 180 days 2.000% Japanese yen LIBOR rate p.a. for the next 180 days0.000%a) Calculate the expected gain in $ from an Uncovered InterestArbitrage (UIA) strategy using the expected spot rate in 90 dayspredicted by Toshi’s research associates.b) The actual spot rate 90 days from today turned out to be72.00(¥/$) instead of 100 (¥/$) as predicted. Discuss how Toshi’sinterest arbitrage strategy in question a) is affected.c) Discuss how a Covered Interest Arbitrage strategy isdifferent from an Uncovered Interest Arbitrage strategy.