Problem 7.7  Akira Numata -- CIA Japan

Akira Numata, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes:

Assumptions

Value

Yen Equivalent

Arbitrage funds available

$5,000,000

          593,000,000

Spot rate (¥/$)

                                                         118.60

180-day forward rate (¥/$)

                                                         117.80

180-day U.S. dollar interest rate

4.800%

180-day Japanese yen interest rate

3.400%

Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency.

Difference in interest rates ( i ¥ - i $)

Forward premium on the yen

CIA profit potential

This tells Toshi Numata that he should borrow yen and invest in the HIGHER yielding currency, the U.S. dollar, to lock-in a covered interest arbitrage (CIA) profit.