Question

4. The oneyear interest rate in New Zealand is 4 percent. The oneyear U.S. interest rate is 10 percent. The spot rate of the New Zealand dollar (NZ$) is $0.50. The forward rate of the New Zealand dollar is $0.54. a) Calculate the covered interest arbitrage profit if feasible for U.S. investors. Assume you start with $1,000,000. b) Calculate the covered interest arbitrage profit if feasible for New Zealand investors. Assume you start with NZ$1,000,000.

Answer 1

Part A:

Take Loan from US Bank, Convert the $ 1,000,000 into NZD using spot Rate.

= 1,000,000 / 0.5

= NZD 2,000,000

Invest this amount for 1 Year

Maturity Value after 1 Year:

= NZD 2,000,000 * 1.04

= NZD 2,080,000

Convert into USD using 1 Year FWd Rate :

= 2080000 * 0.54

= USD 1,123,200

Repay Loan along with Int:

$ 1,000,000 * 1.10

= $ 1,100,000

Book Profit = 1,123,200 - 1,100,000

= 23,200

Part B:

Take Loan from NZ Bank, Convert the NZ$ 1,000,000 into USD using spot Rate.

= 1,000,000 * 0.5

= USD 500,000

Invest this amount for 1 Year

Maturity Value after 1 Year:

= USD 500,000 * 1.10

= USD 550,000

Convert into NZD using 1 Year FWd Rate :

= 550,000 / 0.54

= NZD 1,018,519

pay Loan along with Int:

NZ$ 1,000,000 * 1.04

= NZ$ 1,040,000

Book Profit = 1,018,519 - 1,1,040,000

= NZ$ - 21,481

Pls comment, if any further assistance is required.