1 Are There Any Spot Forward Covered Interest Rate Arbitrage Opportunities Available 2830281

1. Are there any spot-forward covered interest rate arbitrage opportunities available in the AUD-USD markets at any horizon? Start with $1M spot, and show the profit/loss for each of the (6) possible round-trip arbitrages. 2. Working in IBM’s Treasury Department, you need to borrow 10M USD for 6 months. Do you prefer to borrow USD directly, or synthetically using the EUR? Ross School of Business, University of Michigan 701 Tappan Street, Room R4434 Ann Arbor, Michigan 48109-1234 Tel 734-764-9286 Fax 760-268-3746 [email protected] http://webuser.bus.umich.edu/ppasquar/ Paolo Pasquariello Professor of Finance LEADING IN THOUGHT AND ACTION 3. Having invested in Japanese Treasury Bonds, you have a 6-month JPY 100M receivable, which you would like to transform into a 6-month USD receivable. Do you prefer an outright forward or a synthetic using the JPY and USD money markets? 4a. You suspect that the negative quotes for Japanese deposit (bid) rates above are another typo from your typo-prone professor. Calculate a synthetic JPY 90-day deposit rate using the US money market to check whether the negative rates are consistent with the other data. Quote your answer in terms of the synthetic deposit rate’s percent return per annum. 4b. What does it mean for interest rates to be negative? Think about the cash flows associated with lending at negative rates. What is the nominal interest rate associated with putting JPY cash under the mattress or in the cookie jar? Inflation in Japan has recently been running at -1%. How does this affect your thinking? 5. Assuming you believe UIRP is right, what is the expected future USD payoff associated with the JPY 100M receivable of Question 3 if you do not hedge your transactions exchange risk? 6. Assuming UH is true, what is your expectation of spot USD/GBP rates 3, 6, and 12 months in the future? 7. Suppose the price level in the US is expected to be $20,000 in one year while the price level in the UK is expected to be £15,000. If you are a believer in APPP, what exchange rate do you forecast for 1 year from now. How does this differ from UH’s forecast? 8. Suppose you don’t know what the price level in the US or Japan, but you know that US inflation is likely to 3% and Japan inflation is likely to be -1% over the next year. What rate of appreciation / depreciation of the JPY do you expect against the USD?

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