Assume an investor living in Italy can borrow in the domestic lira (ITL) or in the foreign French franc (FRF). Given the following information, determine whether an arbitrage opportunity exists. If so, how much would the investor profit by borrowing ITL 44,280,000 or the equivalent in FRF? (Assume a period of one year & state the profit in domestic currency terms). Spot rate (ITL/FRF) 295.20000 Forward rate (ITL/FRF) 299.10000 Domestic (Italian) interest rate (%) 5.00000 Foreign (French) interest rate (%) 3.50000 A) An arbitrage opportunity results in a profit of ITL 58,725. B) An arbitrage opportunity results in a profit of ITL 1,424,774. C) No arbitrage opportunity. D) An arbitrage opportunity results in a profit of ITL 2,250.
A
44,280,000/295.20000 = 150000 FRF 155446.3390 - 155250 = 196.339 FRF Convert to demestic at FR 196.339*299.10000 = 58724.9949ITL It it A???
Gotta be A.
good job guys. the answer is A. I did it the way that dinesh does it above… is there a shortcut? it seems like it takes me an hour to arrive at the correct answer…
Do you diagram it out. Schweser recommended that for these types of problems and it works out great. I start with a box in the upper left (ITL) and then it’s monetary amt. Box to the right of (French amount) at spot rate. Diagram down both sides the interest rate and revalue the currencies seperately. Then solve for Fwd rate and see where the arbitrage is. This case after diagramming down the ITL side is worth more so that’s the path you would want to take. For me it works out fantastic because I never mix up the forumula. Not sure about your preferences. Actually hoping for some of these on June 7.
^when I mentioned Schweser rec’s it was the vids where they recommended that.
good suggestion. i don’t really diagram it out. i do find my self mixing up where the arbitrage is… i think that is generally one of my problems during the exam. i force myself to go through the questions really fast and try to find shortcuts instead of going through the necessary process. i’m finding it hard to find a balance between getting done on time and accuracy. at L1 time wasn’t a problem, so it may not be l2 either, but i’ve trained myself to go fast which makes me on average lose 2 or 3 questions minimum on practice tests that i should have nailed. did it on the cfa online exam yesterday as well.
I was making some stupid mix ups on which side/ borrow foreign or domestic with the formulas but when I diagram it out, for whatever reason I don’t mess it up. This one takes me about 30 seconds to put together so I can actually go through it faster than some of the theoritical problems where I have to contemplate between two answers. On the sample cfai exams did you find time a problem?
time is not a problem on the cfai sample exam.
I typically calculate F(fair) = S*(1+rdc)/(1+rfc) if F(fair) < actual F -> sell forward, buy spot buying spot = borrowing domestic, lending out foreign if F(fair) > actual F -> buy forward, sell spot