one more for the brain....

 question on international financing -:

 The annual interest rate is 5% in US and 8% in UK.

The spot exchange rate is ₤/$=1.50 and forward exchange rate with one year maturity is ₤/$=1.48. In view of the above fact......that arbitrager can borrow $10,00,000 at current spot rate, what would be the arbitrage profit or loss ?

Answer:

The arbitrager will borrow $ 1,000,000/-from US market for one year and will have to pay a liability of $ 1,050,000/- at the end of the year (since the rate of interest on borrowing in $ is 5% p.a.)

Simultaneously he will convert the $'s into ₤'s i.e. ₤ 666,666.67/- for $ 1,000,000/- (spot exchange rate is $ 1.5 for a ₤). Now he will lent the money so derived in UK market for a year @ 8% p.a.(since the lending rate in UK market is 8%). At the year end he will receive ₤ 720,000/- (i.e. 666,666.67*1.08) & will get converted it into $'s i.e. $ 1,065,600/- (₤720,000*1.48(fwd ex rate)) out of which he will pay the liabilty of Borrowing in $'s amounted to $ 1,050,000/- and will save/earn a profit of $ 15,600/- (i.e. $ 1,065,600 - $ 1,050,000).

Hope u got the solution of ur query.

Regards,

CA Naveen Kumar Agrawal