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Suppose that the treasurer of IBM has chance to borrow of $10,000,000 (or its equivalent in...

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Economics

Suppose that the treasurer of IBM has chance to borrow of$10,000,000 (or its equivalent in other currency) and to invest forthree months. Monthly interest rate in the USA - 1.3% per month, inGermany - 0.6% per month, in London - 0.9% per month. The treasurerof IBM does not wish to bear any exchange risk.

Current spot exchange rate: 0.8045 €/$ and 1.8095 $/£

Three-month forward exchange rate: 0.8098 €/$ and 1.8028 $/£

a. Determine whether the interest rate parity (IRP) is currentlyholding.

b. If the IRP is not holding, how would you carry out coveredinterest arbitrage? Show all the steps and determine the arbitrageprofit.

c. Explain how the IRP will be restored as a result of coveredarbitrage activities.

Answer & Explanation Solved by verified expert
3.7 Ratings (371 Votes)
First we convert the Euro rate to the correct expression Dollar Euro 108045 1243008 Then we use the following formular to calculate CIP forward rates and compare them with the actual forward rates Forward exchange rate Spot exchange rate 1local interest rate 1foreign interest rate Calculations Per    See Answer
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