INTERNATIONAL ARBITRATION AND INTEREST RATE PARITY

QUESTION NO 01
A) Locational Arbitrage. Assume the following information:
Beal Bank
Yardley Bank
Bid Price of New Zealand $
$.401
$.405
Ask Price of New Zealand $ $.404
$.400
Given this information, is locational arbitrage possible? If so, explain the steps involved in
locational arbitrage, and compute the profit from this arbitrage if you had $1 million to use. What
market forces would occur to eliminate any further possibilities of locational arbitrage?
QUESTION NO 02
B) Locational Arbitrage.
AKRON BANK
ZYN BANK
BID
ASK
BID
ASK
British Pounds
$ 1.60
$ 1.61
$ 1.61
$ 1.62
QUESTION NO 03
C) Locational Arbitrage.
NORTH BANK
SOUTH BANK
BID
ASK
BID
ASK
NZ $
$ .635
$ .640
$ .645
$ .650
QUESTION NO 04
The first arbitrage opportunity relates to locational arbitrage. Holt has obtained spot rate
quotations from two banks in Thailand: Minzu Bank and Sobat Bank both located in Bangkok.
The bid and ask prices of Thai baht for each bank are displayed
in the table below:
Minzu Bank
Sobat Bank
Bid
$.0224
$.0228
Ask
$.0227
$.0229
Determine whether the foreign exchange quotations are appropriate. If they are not appropriate,
Determine the profit you could generate by withdrawing $100,000 from Blades checking
account and engaging in arbitrage before the rates are adjusted.
QUESTION NO 05
Besides the bid and ask quotes for the Thai baht provided in the previous question, Minzu Bank
has provided the following quotations for the U.S. dollar and the Japanese yen:
Minzu Bank
Sobat Bank
Value of Japanese yen in $
$.0085
$.0086
Value of Thai baht in
2.69
2.70
Japanese yen
Determine whether the cross exchange rate between the Thai baht and Japanese yen is
appropriate. If it is not appropriate, determine the profit you could generate for Blades by

withdrawing $100,000 from Blades checking account and engaging in triangular arbitrage
before the rates are adjusted.
QUESTION NO 06
Triangular Arbitrage (Without spread)

Assume that a bank has quoted the British pound () at $1.60, the Malaysian ringgit
(MYR) at $.20, and the cross exchange rate at 1= MYR8.1. If you have $10,000, then
how many dollars will you end up with if you implement this triangular arbitrage
strategy?

Triangular Arbitrage (With spread)

Quoted Bid
Price
$ 1.60

Quoted ask price

$ .200

$ .201

MYR 8.10

MYR 8.20

$ 1.61

Value of a British pound in U.S. dollars

Value of a Malaysian ringgit (MYR) in U.S.
dollars
Value of a British pound in Malaysian ringgit
(MYR)
b)
Assume that the following spot exchange rates exist today:
1 = $1:50
C$ = $ .75
1 = C$ 2
Assume no transaction costs. Based on these exchange rates, can triangular arbitrage be used to
earn a profit if you $10000? Explain.
QUESTION NO 07
Triangular Arbitrage. Assume the following information:
Quoted Price
Value of Canadian $ in U S $
$.90
Value of New Zealand $ in U S $
$.30
Value of Canadian $ in New Zealand $
NZ$3.02
Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect
triangular arbitrage, and compute the profit from this strategy if you had $1 million to use. What
market forces would occur to eliminate any further possibilities of triangular arbitrage?
QUESTION NO 08
Triangular Arbitrage: Assume the following exchange rates
Bid Quote
Ask Quote
Value of British pound in
$1.90
$1.91
U.S dollars

Value of Malaysian ringgit

$.300
$.301
(MYR) in U.S dollars
Value of British pound in
MYR 9.10
MYR 9.20
Malaysian ringgit (MYR)
You have $1000, 000 to invest for one year. Would you benefit from engaging in Triangular
arbitrage?
QUESTION NO 09
Assume you are a trader with Deutsche Bank. From the quote screen on your computer terminal,
you notice that Dresdner Bank is quoting 0.7627 / $1.00 and Credit Suisse is offering
SF1.1806/$1.00. You learn that UBS is making a direct market between the Swiss franc and the
euro, with a current /SF quote of .6395. Show how you can make a triangular arbitrage profit by
trading at these prices. (Ignore bid-ask spreads for this problem.) Assume you have $5,000,000
with which to conduct the arbitrage. What happens if you initially sell dollars for Swiss francs?
What /SF price will eliminate triangular arbitrage?
QUESTION NO 10
Covered Interest Arbitrage. Assume the following information:
Spot rate of Canadian dollar
$.80
90-day forward rate of Canadian dollar
$.79
90-day Canadian interest rate
4%
90-day U.S. interest rate
2.5%
Given this information, what would be the yield (percentage return) to a U.S. investor who used
covered interest arbitrage? (Assume the investor invests $1 million.) What market forces would
occur to eliminate any further possibilities of covered interest arbitrage?
QUESTION NO 11
Covered Interest Arbitrage.
Lets consider the situation of Kim Deal, a portfolio manager at BNP Paribas, a French bank.
Kim is trying to decide how to invest :10 million, and she must choose between 1-year euro
deposits and 1-year yen investments. In the latter case, she knows she must worry about
transaction foreign exchange risk, but she also understands that she can use the appropriate
forward contract to eliminate it.
Suppose Kim has the following data:
EUR interest rate:

3.5200% per annum (p.a.)

JPY interest rate:

0.5938% p.a.

Spot exchange rate: 146.0300

1-year forward exchange rate: 141.9021

Which of these investments should Kim choose to get the highest euro return?
QUESTION NO 12
Assume the following information:
You have $800,000 to invest
Spot rate of Canadian dollar
= $1.60
90-day forward rate of Canadian dollar = $1.60
90-day Canadian Interest rate
= 4%
90-day U.S interest rate
=2%
Given this information,
what would be the yield (percentage return) to a U.S investor who used covered interest
arbitrage?
Part B)
Assume that, as a result of covered interest arbitrage, the 90-day forward rate of the pound
declined to $1.5692. Consider the results from using $800,000 (as in the previous example) to
engage in covered interest arbitrage after the forward rate has adjusted.
QUESTION NO 13
Assume the following exchange rates and one-year interest rates
Bid Quote
Ask Quote
Euro Spot
$1.12
$1.13
Euro one-year forward
$1.12
$1.13
Deposit Rate
Loan Rate
Interest rate on dollars
6.0%
9.0%
Interest rate on Euros
6.5%
9.5%
You have $200,000 to invest for one year. Would you benefit from engaging in covered interest
arbitrage?
QUESTION NO 14
Carla Heinz is a portfolio manager for Deutsche Bank. She is considering two alternative
investments of EUR10,000,000: 180-day euro deposits or 180-day Swiss franc (CHF) deposits.
She has decided not to bear transaction foreign exchange risk. Suppose she has the following
data: 180-day CHF interest rate of 8% p.a.; 180-day EUR interest rate of 10% p.a.; spot rate of
EUR1.1960 / CHF; and 180-day forward rate of EUR1.2024 / CHF. Which of these deposits
provides the higher euro return in 180 days? If these were actually market prices, what would
you expect to happen?
QUESTION NO 15
Ben Holt has obtained several forward contract quotations for the Thai baht to determine whether
Covered interest arbitrage may be possible. He was quoted a forward rate of $.0225 per Thai
baht for a 90-day forward contract. The current spot rate is $.0227. Ninety-day interest rates
available to Blades in the United States are 2 percent; while 90-day interest rates in Thailand are

3.75 percent (these rates are not annualized). Holt is aware that covered interest arbitrage, unlike
locational and triangular arbitrage, requires an investment of funds. Thus, he would like to be
able to estimate the dollar profit resulting from arbitrage over and above the dollar amount
available on a 90-day U.S. deposit. Determine whether the forward rate is priced appropriately. If
it is not priced appropriately, determine the profit you could generate for Blades by withdrawing
$100,000 from Blades checking account and engaging in covered interest arbitrage. Measure the
profit as the excess amount above what you could generate by investing in the U.S. money
market.