Question

Suppose that you have an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810 percent (that's a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is 200 Won/$, and the six month forward rate is 220 Won/$, . The interest rate in South Korea (on an investment of comparable risk) is 13 percent. What is your strategy?

Answer 1

The strategy is to convert the U.S. $1,000,000 into Won at the spot exchange rate of 200 Won/$, and then inevest it in South Korea by hedging with a short position in the forward contract.

Step-by-step explanation:

From the question, the following facts can be obtained:

1. The 13 percent interest rate in South Korea (on an investment of comparable risk) is greater than the 1.810 percent (that's a six month rate, not an annual rate) U.S. T-bills.

2. The six month forward rate of 220 Won/$ is greater than the spot exchange rate of 200 Won/$.

Based on the 2 facts above, the best strategy is to convert the U.S. $1,000,000 into Won at the spot exchange rate of 200 Won/$, and then inevest it in South Korea by hedging with a short position in the forward contract.