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One-year interest rates are currently at 9% for New Zealand and 4% for Australia
One-year interest rates are currently at 9% for New Zealand and 4% for Australia. The spot rate is A$0.88/NZ$, while the 1-year forward rate is A$0.88/NZ$. Which of the following correctly describes a profitable arbitrage opportunity?
| A. |
An Australian investor invests in New Zealand securities while agreeing to sell AU$ forward. |
|
| B. |
An Australian investor invests in New Zealand securities while agreeing to sell NZ$ forward. |
|
| C. |
A New Zealand investor invests in Australian securities while agreeing to sell NZ$ forward. |
|
| D. |
There is not enough information to answer the question. |
|
| E. |
None of the options. |
Expert Solution
Answer : B. An Australian investor invests in New Zealand securities while agreeing to sell NZ$ forward
The interest rate is higher in New Zealand @ 9% than in Australia, which is @ 4%
Hence, the investor will borrow in Australia at a lower rate and invest in New Zealand at a higher rate
After 1 year, the investor will want to convert the NZ$ into A$, hence the investor will enter into a forward contract to sell NZ$ after 1 year and buy A$ (to sell NZ$ and buy A$)
Hence, the correct answer is B.
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