The paper "International Financial Management" is a perfect example of an assignment on finance and accounting. Q1). The geographical arbitrage profit with the two exchange rates The existing exchanged rates as depicted in the stock market of different states between Westpac bank in Sydney and the Barclays bank in London as at the transaction date is as follows Westpac Sydney Barclays London A$ 1.1840-60/€ A$ 1.1830-50/€ The exchange ratio, therefore, is as follows In Sydney (west pack bank) ($1.184/60) = 0.0197 In Barclays (Barclays bank) (1.185/60) = 0.0198 As of the above exchange ratio examination, it can be observed that the Euros is overvalued in Westpac bank in Sydney and undervalued in Barclays bank in London.
This is only an effective comparison holding other factors constant, that there was a free flow of capital among the two financial institutions. Consequently, an arbitrageur’ s determination is to take benefit of the undervalued exchange by disposing the dollars in London and re-selling them in Westpac bank so as to take home the yields arising from taking advantage of the currency weakness. For that reason, if $ 1 million is sold in London, arbitrageurs will obtain a return corresponding to ($1 million * 0.0198 = € 98,000 Where $ 1 million is sold again in Sydney at the same time, an arbitrageur’ s will have a yield on the return of (60/€ *€ 98,000/ $ 1.1840 = € 3, 195,652.17 For this reason, total arbitrage profit that will be earned by an investor in Sydney would be (3, 195,652.17 – 1098, 000) = € 2,097,652.17.
When an investor changes this amount from Euros to US dollars, it will give him an arbitrage profit of (€ 2,097,652.178 1.181}/60} =- $ 41,393.67 In conclusion, the arbitrage process is considered vital because an investor would earn profit out of the weaker currency, and thus take full advantage of arbitrage process, an arbitrageur’ s needs to have full knowledge of how the stock market of different shares are trading.
Consequently, to take advantage of the weak performing currency in the security market, an arbitrageur must consider disposing of the undervalued currency and buying the overvalued currency in the west pack bank in order to earn an arbitrage profit. Q2). The diagram and the relevant procedure Toshi Numata must take to make a covered interest arbitrage profit Initial capital investment $ 2 million 6-month forward exchange rate 109.8 Japanese yen deposit rate of 1.8% Existing Spot rate 110.2 Dollar deposit interest rate 3% If Toshi Numata will invest the $ 2 million in the country, it will yield him a return of ($ 2 million * 1.8 %} + $ 2 million) = $ 20036,000 If Toshi Numata will ignore the compounding and hence exchange the future worth of Japanese yen for dollars at the future-forward exchange rate for 180 days, he will earn a yield of Investing today ($ 2 million/ 110.2 Spot rate) = $18,148.62 180 days forward exchange rate ($18.148.62* 3%)* 109.8 forward exchange rate} = $ 18,693.28 Exchange to US dollars.
($ 18,693.28/110.2} = $ 2,052,522.65 Therefore, covered arbitrage returns would be ($ 2 million - $2,052,522.65) = $52,522.65 Diagrammatic representation of covered interest arbitrage start end $20,036,000 2 million 1.8% $2,052,522.65 spot rate 110.2 forward premium 109.8 $18,148.82 the growth rate of 3% 18,693.28 From the above presentation, a profit from the covered interest arbitrage is envisaged and thus an investor should consider investing in West Pac bank. The above diagram gives a detailed procedure that a potential investor would follow in order to realize profit out of the covered arbitrage interest process.
The process starts systematically from the beginning to the end. (Madura, 2011) Q3). Expected US dollar in relation to this analysis
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Madura, J. (2011). In International Financial Management, 11th ed (p. ppg 153).
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Clark, E. (2002). In International Finance.