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This document discusses two examples of potential currency arbitrage opportunities: 1) Investing dollars in Japan at 3.95% yields a higher return than investing in the US at 2.25% due to differences in interest rates. Absent transaction costs, it would be profitable to borrow dollars in the US and invest them in Japan. 2) Initially, investing euros in Germany at 7% yielded a higher 9.25% return in dollars than investing dollars in the US at 9%. However, after the euro weakened, the dollar return fell to -0.30%, eliminating potential arbitrage profits and capital flows.

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11 views1 page

C C!" # $ C"%&C'C!C C' ( (&%% (!" + # + # #, # + - # # - # /#0 .%% - (# C (%% # C" 1 C'&' (!' (C) (% & ( +'% 2 # - # 3 C'&' (!' (&' ( (%C' ' ' # ##

This document discusses two examples of potential currency arbitrage opportunities: 1) Investing dollars in Japan at 3.95% yields a higher return than investing in the US at 2.25% due to differences in interest rates. Absent transaction costs, it would be profitable to borrow dollars in the US and invest them in Japan. 2) Initially, investing euros in Germany at 7% yielded a higher 9.25% return in dollars than investing dollars in the US at 9%. However, after the euro weakened, the dollar return fell to -0.30%, eliminating potential arbitrage profits and capital flows.

Uploaded by

Arpita Panda
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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13> a) The dollar return from a three-month investment in Japan can be found by converting dollars to yen at the spot

rate, investing the yen at 1.75% (7%/4), and then selling the proceeds forward for dollars. This yields a dollar return equal to 142 x 1.0175/139 = 1.0395 or 3.95%. This return significantly exceeds the 2.25% (9%/4) return available from investing in the United States. b) The flip side of a lower return in the United States is a lower borrowing cost. Borrow in the United States. c) Absent transaction costs that would wipe out the yield differential, it makes sense to borrow dollars in New York at 2.25% and invest them in Tokyo at 3.95%. d) The profit would be a 1.7% (3.95% - 2.25%) return per dollar borrowed. 14> a)The annual dollar return on dollars invested in Germany is (1.07 x 0.97)/0.95 - 1 = 9.25%. This return exceeds the 9% return on dollars invested in the United States by 0.25% per annum. Hence arbitrage profits can be earned by borrowing dollars or selling dollar assets, buying euros in the spot market, investing the euros at 7%, and simultaneously selling the euro interest and principal forward for one year for dollars b) In this case, the return on arbitraging dollars falls to 1.07 x 0.97/0.95 x 0.99752 - 1.09 = -0.30% Thus, arbitraging from dollars to euros has now become unprofitable and no capital flow will occur.

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