Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the forward exchange rate, with one-year maturity, is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000 or €892,857 (which is the equivalent of $1,000,000 at the spot exchange rate of $1.12/€).
-The net cash flow in one year is
A) $10,690.
B) $15,873.
C) $46,207.
D) $21,964.

Question

Quizplus · Accepted Answer

$1,000,000 borrowed at 5% and converted to Euros on spot exchange rate = $1,000,000 × $1.12/€ = €892,857€892,857 was invested at 3.5% in Germany which grew to:€892,857 × 1.035 = €924,107This amount of €924,107 was converted back to US dollars at $1.16/€, i.e€924,107 × $1.16/€ = 1,071,964Interest on borrowed money:$1,000,000 × 5% = $50,000Cash flow after paying interest and principal amount:$1,071,964 - $1,000,000 - $50,000 = $21,964

Suppose That the Annual Interest Rate Is 5