Two-way currency exchange
1) Invest all of the funds in a one-year U.S. Treasury bill offering a bond equivalent yield of 4.25 percent
2) Invest all of the funds in a Swiss government security over the same horizon, locking in the spot and forward currency exchanges in the FX market.
Funds to invest =
US T-bill yield =
Swiss Gov Bond =
a. Calculate the one-year bond equivalent yield for the Swiss Government security that would support the interest rate parity condition.
b. Assuming the actual yield on a one-year Swiss government bond is 5.5 percent, which strategy would leave the treasurer the greatest return after one year?
c. Describe the transactions that an aritrageur could use to take advantage of this apparent mispricing, and calculate what the profit would be for a $250,000 transaction.