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Answer :
a) James can gain $80,000 in interest from investing in the US bank. Calculating the principal and interest gained from investing in the US bank:Principal: $8,000,000 USD.
Interest Rate: 4.000%,Time Period: 3 months.Interest gained from investing in the US bank can be calculated using the formula: Interest = Principal * Interest Rate * Time Period
Interest = $8,000,000 * 0.04 * (3/12)..
Interest = $80,000 .Therefore, James can gain $80,000 in interest from investing in the US bank.
b) Calculating the principal and interest gained from investing in the UK bank: Principal: $8,000,000 USD,Spot Exchange Rate (GBP/$): 7.1720,Forward Exchange Rate (GBP/$): 7.1980,Time Period: 3 months. To calculate the principal in GBP, we divide the principal in USD by the spot exchange rate: Principal in GBP = Principal in USD / Spot Exchange Rate. Principal in GBP = $8,000,000 / 7.1720.
Principal in GBP = £1,114,562.47. To calculate the interest gained from investing in the UK bank, we need to consider the interest rate differential between the US and UK: Interest Rate Differential = UK Pound Interest Rate - US Dollar Interest Rate,Interest Rate Differential = 6.000% - 4.000%,Interest Rate Differential = 2.000%.
Interest gained from investing in the UK bank can be calculated using the formula:Interest = Principal in GBP * Interest Rate Differential * Time Period. Interest = £1,114,562.47 * 0.02 * (3/12),Interest = £8,361.97.To convert the interest gained from GBP to USD, we multiply it by the forward exchange rate:Interest in USD = Interest in GBP * Forward Exchange Rate. Interest in USD = £8,361.97 * 7.1980. Interest in USD = $60,144.09. Therefore, James can gain $60,144.09 in interest from investing in the UK bank.
c) To determine if James can make a covered interest arbitrage (CIA) profit, we compare the interest gained from investing in the US bank ($80,000) with the interest gained from investing in the UK bank ($60,144.09). Since the interest gained from the US bank is higher, there is no arbitrage opportunity available for James. He would earn more by investing in the US bank rather than engaging in covered interest arbitrage with the UK.
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