Question

Toshi Numata of Credit Suisse First Boston (Tokyo) is exploring covered interest arbitrage (CIA) possibilities in the market given the following current market quotes.

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Identify the arbitrage opportunity and report your profit. Please not that interest rates are expressed in per annum (annualized terms); do not forget to make necessary adjustments. (Round your answers to next integer)

a)JPY15,700,000

b)USD 15,700

c)USD142,727

d)JPY142,727,000

Answer 1

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Answer:

Step 1: Calculate the yen equivalent: $2,000,000 × ¥120/$ = ¥ 240,000,000

Step 2: Convert ¥ 240,000,000 at the spot rate ¥110.20/$: ¥ 220,400,000÷ ¥1200/$ = $2,000,000

Step 3: Invest the proceeds in a dollar account for 180 days, earning 5% per year. In 180 days: $2,000,000 × (1+ (0.05÷2)) = $2,050,000

Step 4: Simultaneously sell the future dollar proceeds forward for yens at the 180-day forward rate ¥110.00/$. → “locks in” gross yen revenues: $2,050,000 × ¥110.00/$ = ¥225,500,000

Step 5: Calculate the cost (opportunity cost) of funds: ¥ 240,000,000 × (1+ 0.01÷2) = ¥241,200,000 Profit on CIA: ¥241,200,000－¥225,500,000 = ¥15,700,000