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Homework answers / question archive / The following information is available: You have $500,000 to invest

The following information is available: You have $500,000 to invest

Finance

The following information is available: You have $500,000 to invest. The current spot rate of the New Zealand dollar (NZS) is $0.41. The 90-day forward rate of the New Zealand dollar is $.42. The 90-day interest rate in the U.S. is 9 percent. The 90-day interest rate in New Zealand is 8 percent. What is the yield to a U.S. investor who conducts covered interest arbitrage? Did covered interest arbitrage work for the investor in this case?

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The US investor borrows $ 500,000 for 90 days @ 9% and converts it into NZD (New Zealand Dollar) @ 0.41 USD per NZD. Hence, he gets NZD 1,219,512.20

Now he invests NZD 1,219,512.20 @ 8% p.a. for 90 days which gives NZD 1,219,512.20 * 1.02 = NZD 1,243,902.44.

This amount is subsequently reconverted to USD @ forward rate of 0.42 USD per NZD which is equivalent to 1,243,902.44 * 0.42 = USD 522,439.02 (A)

The investor needs to repay the borrowed amount along with interest @ 9% p.a. for 90 days = USD 500,000 * 1.0225 = USD 511,250 (B)

Net arbitrage gain = (A) - (B) = USD 522,439.02 - USD 511,250 = USD 11,189.02.

Yield% = USD 11,189.02. / USD 500,000 * 365 days / 90 days = 9.07% p.a.

Yes, arbitrage worked for the investor in this case.

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