Question

Assume the following information: You have $1,000,000 to invest: Current spot rate of pound = $1.32 90-day forward rate of pound = $1.29 3-month deposit rate in U.S. = 2.5% 3-month deposit rate in Great Britain = 3.75% If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days?

Answer 1

$1,013,920.46

Step-by-step explanation:

Spot Rate: 1 Pound = $1.32

3 Months Forward Rate = $1.29

3 Months Deposit rate in US = 2.5%

3 Months Deposit rate in Great Britain = 3.75%

Total Amount of Investment = $1,000,000.

We convert $1,000,000 into Pounds using Spot rate

1 Pound = $1.32

Hence, $1,000,000/1.32 = 757,575.76

We Invest 757,575.7575757576 Pounds in great Britain for 3 months at an interest rate of 3.75%

= 757,575.76 * 3.75%

= 28409.09

Hence, the total realizable value after 3 months = 757,575.76 + 28409.09 = 785,984.85 pounds

We convert 785,984.85 Pounds into Dollars using Forward rate

= 785,984.85 Pounds * $1.29

= 1013920.4565

= $1,013,920.46

Hence, we will have the amount of $1,013,920.46 after 90 days.