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Exercise Irp

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35 views14 pages

Exercise Irp

Uploaded by

nfasuhaimee
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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EXERCISE IRP

 QUESTION 1
 An investor will invest his funds in any market to maximize profit.

The one-year Malaysian interest rate and US interest rate is 6%


per annum and 10% per annum, respectively. The spot rate for
RM3.5600/20/USD and the one year forward rate is
RM3.6400/40/USD.
1) Are there any interest arbitrage opportunities?
2) Assist the investor on where he should borrow and invest?
3) Explain how the investor can profit from the situation. (Assume
the initial investment by Malaysian investor is RM10,000,000)

1
 Step 1: Determine the existence of a covered interest arbitrage
Forward premium @ discount annualized = Interest difference
Forward rate – Spot rate x 360 x 100 = rhc - rfc
Spot rate Fwd contract days
[(3.6400 – 3.5600)/3.5600] x 360/360 x 100 = 6% -10%
2.25% ≠ -4% , Therefore CIA exist

 Step 2: Decide whether to invest home or abroad


(1 + rhc)t = (1 + rfc)t F
S
(1 + 0.06) = (1 + 0.10) (3.6400/3.5600)

1.06 < 1.12 , Borrow HC; Invest FC


2
RM USD

T = Now

1) Borrow HC @ 6% 10,000,000

2) Convert to FC @ RM3.5620 (Buy USD, (10,000,000) 2,807,411.57


Bank Sell)
3) Invest FC @ 10% (2,807,411.57)
Enter forward rate @ RM3.6400

T = 1 year

4) Return from investment 3,088,152.73


2,807,411.57 x (1 + 0.1)
5) Convert to RM @ RM3.6400 11,240,875.93

6) Pay borrowings 10,600,000


10,000,000 x (1+ 0.06)
PROFIT 640,875.93
3
QUESTION 2
 Suppose that the current spot exchange rate is
EUR0.8000/USD and the 3-month forward
exchange rate is EUR0.7813/USD. The 3-month
interest rate is 8% per annum in the United States
and 5.40% per annum in France. Assume that you
can borrow up to USD1,000,000 or EUR800,000.
Show how you can make a profit from covered
interest arbitrage (CIA).
(10 marks)
4
5
6
EURO USD

T = Now

1) Borrow FC @ 8%/4 1,000,000

2) Convert to US to EURO @ 800,000


EURO0.8000
3) Invest HC @ 5.4%/4 (800,000)
Enter forward rate @ EURO0.7813

T = 3 month

4) Return from investment 810,800


800,000 x (1 + 0.054/4)
5) Total Borrowings 1,020,000
USD 1,000,000 (1 + 0.08/4)
6) Pay borrowings in Euro 796,926
USD1,020,000 x Euro0.7813
PROFIT 13,874
7
QUESTION 3
 Airuz Bhd are given the following quotes:

 Spot rate RM3.7810/JPY100


 One year forward rate RM3.9200/JPY100
 Interest rate Malaysia 10.5% per annum
 Interest rate Japan 8.0% per annum

 Assume that Airuz Bhd can borrow as much as RM5 million or


JPY500 million for their coming project. If Interest Rate Parity
(IRP) is not holding, determine how Airuz Bhd can profit from
covered interest arbitrage (CIA) opportunity.
(10 marks)
8
 STEP 2
 1 + rhc = (1+rfc) F/S
 1+ 0.105 = (1+ 0.08)3.9200/3.7810
 1.105 < 1.120

 Borrow home (RM) and invest foreign (JPY) √

9
 T = Now
 Borrow RM5,000,000

 Convert RM to JPY
 RM5,000,000 ÷ RM3.7810/100√
 = JPY132,240,148.10 √

 Invest in Foreign (JPY), JPY132,240,148.10

 Enter forward contract RM3.9200/JPY100

10
 T = 1 year
 Return from investment
 JPY132,240,148.10 x (1+ 0.08) √
 = JPY142,819,360 √

 Convert all JPY to RM using forward rate
 JPY142,819,360 x RM3.9200/100 √
 = RM 5,598,518.91 √

 Pay all borrowings
 RM5,000,000 x (1+0.105) √
 = RM5,525,000 √

11
 RM 5,598,518.91 - RM5,525,000
 = RM73,518.91 –> profit √

12
QUESTION 4
 Miss Mel, a currency dealer can either borrow or invest GBP1,200,000.
The following data is available to enable her to perform covered interest
arbitrage (CIA) transactions.

 Ringgit interest rate : 12 percent per annum


 GBP interest rate : 8 percent per annum
 Spot rate : MYR5.5600/25/GBP
 6-month forward rate : MYR5.6720/45/GBP

 Show the CIA steps and determine the profit (in MYR) that Miss Mel may
earn.

 (10 marks)
13
STEP 2
(1+ rhc) = (1+rfc) x ft/e0
(1.06) = (1.04) x 5.6720/5.5600
1.06 < 1.0609 √
Thus, CIA can be done by borrowing HC (RM) and invest in FC (GBP) √

T = Now MYR GBP


Borrow MYR @ 6% for 6 months 6,675,000
Convert: Use the MYR buy GBP (6,675,000) √ 1,200,000
= GBP1,200,000 x RM5.5625
Invest the GBP @ 4% for 6 months (1,200,000) √

Enter 6-mths forward to Sell GDP @ 5.6720

T = 6-months’
Receive the GBP investment (1,200,000 x 1.04) 1,248,000
Deliver (sell) the GBP under forward 7,078,656 √ (1,248,000) √
= GBP1,248,000 x RM5.6720
Payment of MYR loan = RM6,675,000 x 1.06 (7,075,500) √
CIA profit (in MYR) 3,156 √√
14

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