Transcript Covered Interest Arbitrage

Covered Interest Arbitrage—
Raul Thinks Big
International Finance
Dick Sweeney
Where to Deposit Funds? Schema
Start with SEK 1m
Finish with SEK ??
SEK 1m / S
SEK 1m
(SEK 1m / S)
x (1 + iusd) x F
SEK 1m
x (1 + isek)
*Sell SEK 1m for USD
at spot rate S
*Deposit USD at iusd
*Convert (1 + iusd) to
SEK at forward rate F
Deposit SEK 1m
at isek
Where to Deposit Funds? Alternative Payoffs
Start with SEK 1 m
Finish with SEK ??
SEK 1 m / S
= 1 m / 10
= USD 100,000
USD 100,000
x (1 + 4.50/400)
x SEK 10.1
= SEK 1.0213625m
Difference =
1.0213625m - 1.0200m
= SEK 1362.5
SEK 1 m
x (1 + 8.00/400)
= SEK 1.0200 m
SEK 1 m
*Sell SEK 1 m for USD
at spot rate S
*Deposit USD at iusd
*Convert (1 + iusd) to
SEK at forward rate F
Deposit SEK 10,000
at isek
Covered Interest Arbitrage:Schema
Borrow SEK from SEBank
Lend USD to LABank
Deliver USD,
Get SEK
Sell USD Forward to
SEBank for SEK
Get USD
Sell SEK
Sell SEK to
SEBank for USD,
to Lend USD to LABank
Covered Interest Arbitrage: Profits
Borrow SEK from SEBank (8 %)
Lend USD to LABank (4.5 %)
Deliver USD,
Get SEK, at 10.1
Sell USD Forward to
SEBank for SEK
Get USD, at 10.0
Profits:
SEK 1362.5
in 3 mths,
SEK ????
now
Sell SEK
Sell SEK Spot to
SEBank for USD,
to Lend USD to LABank