Interest arbitrage transaction

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You are a currency arbitrager for a Japanese bank. The spot rate this morning is IPY/USD 125.50, and early indications are that short-term interest rates in the United States [60-day rates] are about to rise from their current level of 5 percent. The Federal Reserve is worried about rising in?ation and has announced that it is considering increasing short-term interest rates by 30 basis points [0.30 percent). The 60-day forward rates quoted this morning to you by local banks are all about the same, lPY/USD 125.52. The current 30-day yen deposit rate of interest is 2.75 percent. You have ¥300 million to invest.

a. How can you make a pro?t through an interest arbitrage transaction? How much pro?t in yen can you hope to make in 60 days, given the above data?

b. If future spot exchange rates are determined by interest-rate, what would you expect the spot rate to be in 60 days if the Federal Reserve were to increase interest rates by 35 basis points?

Reference no: EM133060787

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