Currently, the spot exchange rate is CHF 0.89/$ and the three-month forward exchange rate is CHF 0.86/$. The three-month interest rate is 5.6% per annum in the U.S. and 4.0% per annum in Switzerland. Assume that you can borrow as much as $1,120,000 or CHF 1,000,000. Determine whether the interest rate parity is currently holding.If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit.Explain how the IRP will be restored as a result of covered arbitrage activities.

Interest rate parity refers to the no-arbitrage condition in which the interest rates available to…

Answered: Currently, the spot exchange rate is…

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter7: International Arbitrage And Interest Rate Parity

Section: Chapter Questions

Problem 19QA

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Currently, the spot exchange rate is CHF 0.89/$ and the three-month forward exchange rate is CHF 0.86/$. The three-month interest rate is 5.6% per annum in the U.S. and 4.0% per annum in Switzerland. Assume that you can borrow as much as $1,120,000 or CHF 1,000,000.

Determine whether the interest rate parity is currently holding.
If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit.
Explain how the IRP will be restored as a result of covered arbitrage activities.

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