Question

Copenhagen Covered​ (C). Heidi​ Høi Jensen, a foreign exchange trader at J.P. Morgan​ Chase, can invest ​$4.954.95 ​million, or the foreign currency equivalent of the​ bank's short term​ funds, in a covered interest arbitrage with Denmark. She is now evaluating the arbitrage profit potential in the same market after interest rates change.​ (Note that anytime the difference in interest rates does not exactly equal the forward​ premium, it must be possible to make CIA profit one way or​ another.)

Arbitrage funds available	$	4,950,000
Spot exchange rate (kr/$)		6.1716
3-month forward rate (kr/$)		6.1978
US dollar annual interest rate		2.900	%
Danish kroner annual interest rate		5.950	%

A. The CIA profit potential is (%)

B. which tells Heidi​ Høi Jensen that she should borrow (Danish kroner or US Dollar)

C. and invest in the (higher or lower) interest rate​ currency,

D. ​(the dollar or krone) gaining on the​ re-exchange of kroner for dollars at the end of the period.  ​(Round to three decimal places and select from the​ drop-down menus.)

E. The CIA profit amount is ($)

​(Round to the nearest​ cent.)

Answer 1

The strategy will work as follows:

Borrow US $ 4,950,000

CONVERT into DK At spot rate = 4,950,000*6.1716 = DK 30,549,420

Invest in higher interest currency and get 30,549,420(1+0.05950*3/12) = DK 31,003,842.62

Convert back into USD = 31,003,842.62/6.1978 = USD5,002,394.82

RATE OF return = (5,002,394.82-4,950,000)/4,950,000

= 1.0585%

US dollar annual interest rate = 2.9%*3/12 =0.725%

Profit potential = 0.3335%

Profit amount = 5,002,394.82-4,950,000(1+0.029*3/12)

= $16,507.32