Question

Currently, the spot exchange rate is $0.85/A$, and the one-year forward exchange rate is $0.81/A$. One-year interest is 3.5% in the United States and 4.2% in Australia. You may borrow up to $1,000,000 or A$1,176,471, which is equivalent to $1,000,000 at the current spot rate.

1. Determine if Interest Rate Parity (IRP) is holding between Australia and the United States.
2. If IRP is not holding, explain in detail how you would realize certain profit in U.S. dollar terms.
3. Explain how IRP will be restored as a result of arbitrage transactions you carry out above.

Answer 1

Ans Current spot Exchange Rate = 0.85 /A$ One year four ward Exchange Rate = $0.81/A Interest lade in US = 3.5% Interest Rate in Australia = 4.2 0 Rate Red Parity = forward Rute [lt Iush ) Spot Rate (1 + I Aus ) Interest 0.81 1 4 0.85 .2. (1+ 3.5%) (1+4.2%) 0.952g * 0.9933 since the two values interest Rate Re Parity are not approximately equal does not exists there forre

Barrow 1176471 in Australian market @of 4.2% Convort this amount into USD @ 0.85/AS = 1176471 x 0.85 O = $ 1000000 Invest this $ 1000000 @ of 3% = 1000000 x(1+34) = $1030000 Simultaneously for sell of enter into a one 99 2965.0534 year forward contract for the 1176471 * (10 4.27.) = 1225882.782 is the obligation in lyear in Australien Market this is has to sap cover thorough amount we have invested in USD market so 1225882.782 x 0.8) =$ 992965. 0534 Profit - Carbitrage profit) 1030000 - 99 2965.0534 $37034. 9466 covered Interest Rate parity = Fourward Rate = spot Rate & (1+ I und) (1+ TAB) = 0.85 x (1 + 37.) (1+ 4.21) forward Rute - 0.8402 forward Rute should be 0.8402 instead of o.s1 ato Remove arbitrage Profit so the