Quotes for the US dollar US and Thai Baht Bt are as follow S

Quotes for the US dollar (US$) and Thai Baht (Bt) are as follow:

Spot contract midpoint S0Bt/US$=Bt 24.96/US$
1-year forward midpoint F0Bt/US$=Bt25.64?US$
1-year Eurodollar interest rate I$=6.125%per year

a) Your newspaper does not quote 1-year Eurocurrency interest rates on thai baht. Make your own estimate of iBt.

b) Suppose that you can trade at the prices for S0Bt/US$ , F0Bt/US$ and I$ just given and that you can also either borrow or lend at a Eurocurrency interest rate of iBt = 10% per cent. Based on a $1 million initial amount, how much profit can you generate through covered interest arbitrage ?

Solution

The answer to question

a.Since the newspaper does not quote 1-Year Eurocurrency interest rates on thai baht.Make your own assumption of iBt

Using the interest rate parity condition (no covered interest arbitrage)
Forward rate / Spot rate = (1+ Thai baht eurocurrency interest rate) / (1+ Euro dollar interest rate)
or 25.64 / 24.96 = (1+ Thai baht eurocurrency interest rate) / (1+ 6.125%)

Thai Baht

1.027=(1+Thai baht eurocurrency interest rate)/(1+6.125%)

(1+Thai baht eurocurrency interest rate)=1.027/(1+.06125)

                                                         =.9377

or Thai Baht eurcurrency interest rate = 1-.9377

                                                       =.0322

b.Assuming a loan of $1million

Borrow US$ convert to Bt ->$ 1Million *24.96

                                        = $24.96

$ 24.96 invested for 1 year ->FV=PV(1+i)ⁿ

                                                             ^=24.96(1.10)

                                              =27.46

Convert again $27.46 back to iBt ->$27.46/(1.06125)

                                                  =iBt 25.87

Loan amount need to repay in iBt ->25.87(1.1)

                                                   iBt 28.45

Net difference =(28.45-25.87)

                        =iBt 2.58