FIN 3410 Lecture Notes - Lecture 13: Arbitrage

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Day 13 & 14 Notes
EX CH15 5
Background
Currency carry trade
A Bermuda-based hedge fund manager
I$ = 6%
IY = 2.8%
The fund manager borrowed Y 1 billion for one year and invested in the US
So = Y95/$
S1 = Y105/$
Problem
Profit($) = revenue($) cost($)
o Revenue($) = FV($investment)
o Cost($) = $equivalent of Y(loan+int)
1. Revenue($) = FV ($ investment)
a. = [loanY / So(Y/$)] * (1 + i$)
b. = [Y1 billion / (Y95/$)] * (1 + 0.06)
c. = $11,157,895
2. Cost($) = $equivalent of Y(loan+int)
a. = Y(loan+int) / S1(Y/$)
b. = [Y1 billion * (1 + 0.028)] / (Y105/$)
c. = $9,790,476
3. Profit($) = revenue($) cost($)
a. = $11,157,895 - $9,790,476
b. = $1,367,419
i. A loss is okay
EX CH15 4
Background
Io$ = $10,000,000 initial investment in pure-discount bonds
So = Y 80/$
I1$ = $10,650,000
S1 = Y 110/$
rY = ?
S1 > So
o $ appreciation against Y
Approach 1
I1Y = I1$ * S1(Y/$)
o $10,650,000 * Y 110/$ = Y 1,171,500,000
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