Arghhhbitrage

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noseykibitzer

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Why can't we just have one universal currency would make the world a whole lot simpler and this problem too.

If your dealing with $1,000,000

Spot = .02312 $/Baht
Forward = .02200 $/Baht
US Interest rate = 4.50%
Thailand Interest rate = 6.00%

What is the arbitrage profit?

A) Borrow $, Arbitrage profits are $36,349
B) Borrow Baht, Arbitrage profits are $36,349
C) No arbitrage profits
D) Borrow Baht, Arbitrage Profits are $65,622
 
Since the forex is given in dollars per baht, it's easier to assume that this is a direct quote, which means that the home country is U.S.

Compare if 1000000 invested in US for one year yields the same return as the same amount invested in Thailand.

1000000 x (1 + 0.0450) = 1000000/.02312 x (1 + 0.06) x .02200
1045000 = 1008651 (not equal to rather).

$1000000 invested in the US yields 45,000 while $1000000 invested in Thailand yields 8,651. Hence, borrow in Thailand, lend in US., make the difference of 36,349, live the life of luxury.
 
I was trying to find a simpler way of figuring it out instead of putting the equality to "0" and then doing the if negative then borrow in domestic and positive then borrow foreign Thingy.

Thanks
 
Lev - what's the formula breakdown for that again. I don't have my books here at work and I can't remember how you do these? Thanks!
 
1. Determine which country is a home country
2. Your objective is to see if $1 invested at home will yield the same return as $1 invested abroad. If not, you have the arb opportunity on your hands (borrow at lower yielding country and lend at higher yielding country).
3. Set the home country on the left side of the "equals" sign. You have $1 and you invest it at home at the one-year risk free rate (4.5%). Thus, you know that at home you will get one buck and four and a half cents in one year. Now take another $1, convert it into baht ($1/0.02312), invest it at the local one year rate of 6% ($1/0.02312 * 1.06), when the year ends, convert your bahts back into dollars at the 1-year forward rate ($1/0.02312 * 1.06 * 0.022). If you have less than $1.045, borrow in Thailand and lend in US.
 
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