DVU Forward Exchange and Triangular Arbitrage Questions

1. New York Co. has agreed to pay 11 million Australian dollars (A$) in two years for equipment that it is importing from Australia. The spot rate of the Australian dollar is $0.60. The annualized U.S. interest rate is 3 percent, regardless of the debt maturity. The annualized Australian dollar interest rate is 14 percent, regardless of the debt maturity. New York plans to hedge its exposure with a forward contract that it will arrange today. Assume that interest rate parity exists. Determine the amount of U.S. dollars that New York Co. will need in two years to make its payment. Enter your answer as a positive value. Do not round intermediate calculations. Round your answer to the nearest dollar.

2. You go to a bank and are given these quotes:

You can buy a euro for 17 pesos.
The bank will pay you 16 pesos for a euro.
You can buy a U.S. dollar for 0.69 euros.
The bank will pay you 0.61 euros for a U.S. dollar.
You can buy a U.S. dollar for 14 pesos.
The bank will pay you 12 pesos for a U.S. dollar.

You have $2,000. Can you use triangular arbitrage to generate a profit? If so, explain the order of the transactions that you would execute. If you cannot earn a profit from triangular arbitrage, explain why.

1. Yes, you can generate a profit by converting dollars to euros, and then euros to pesos, and then pesos to dollars.
2. Yes, you can generate a profit by converting dollars to pesos, and then pesos to euros, and then euros to dollars.
3. No, triangular arbitrage is not possible because the quoted cross exchange rates do not differ from the rates that should exist.

Compute the profit that you would earn using triangular arbitrage. Enter “0”, if you incur a loss. Do not round intermediate calculations. Round your answer to the nearest cent.

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