SEBank BAnswers, Short Version

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SEBank (B)Answers, Short Version

• International Finance
• Dick Sweeney

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Short Summary

• Covered interest arbitrage profits exist if Ms.
  Juselius borrows SEK and lends (deposits)
  USDprofits are SEK 2,215 or really SEK 2,214.5.
• She borrows SEK 1m and converts these to USD at
  the spot rate 9.1241.
• In three months, she gets USD and converts these
  to SEK at the forward rate 9.1580.
• She pays the interest rate 7 ¼ on the borrowed
  SEK.
• She receives the interest rate 6 5/8 on deposited
  USD.

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Borrowing and Lending (Depositing)
transactionswhich bank?

• Borrow SEK 1 m for three months from SEBank at 7
  1/4 (offer rate banks lending rate to
  customers). Owes SEK 1,018,125 in three months.
• Lend USD 109,599.85 for three months to SEBank at
  6 5/8 (deposit rate banks borrowing rate from
  customers). Receives USD 111,415.10 in three
  months.

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Currency transactionswhich bank?

• Buy USD spot from Danish bank for SEK 1 m, at
  9.1241 (offer price), receiving USD 109,599.85
  spot.
• Sell USD 111,415.10 forward three months to the
  Danish bank for SEK, at 9.1580 (bid price),
  receiving SEK 1,020,339.5 in three months.

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Timing issueswhich bank? When? How much?

• Spot She pays the Danish bank SEK 1 m spot with
  the proceeds from borrowing SEK 1 m for three
  months from SEBank.
• In three months She receives USD 111,415.10 from
  SEBank for the USD she deposited (lent it). She
  uses these dollars to pay the Danish bank for the
  forward contract she made to sell USD 111,415 for
  SEK. She receives SEK 1,020,339.5 from the Danish
  bank.
• She owes SEBank the amount SEK 1,018,125 for the
  SEK 1 m she borrowed.
• This leaves her with SEK 2214.5 ( SEK
  1,020,339.5 - SEK 1,018,125).

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Present value of profits

• This SEK 2214.5 has a present value of SEK
  2,175.05
• SEK 2,175.05 SEK
  2214.5 / (1 7.25/400) SEK 2214.5 /
  (1.018125)
• Note Have to use borrowing rate to calculate
  present value

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Some details

• Bid Offer Spread
• ?
• Spot 9.1180 9.1241 61
• 1-month 170 190 (81 61 20)
• 9.1350 9.1431 81
• 3-month 9.1180 9.1241 61
• 400 450 (111 61 50)
• 9.1580 9.1691 111
• 6-month 9.1180 9.1241 61
• 600 700 (161 61 100)
• 9.1780 9.1941 161

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More details

• SEBanks money-rate quotes are
• money rates lending (by SEBank) borrowing (by
  SEBank)
• 3-months
• USD 6 11/16 6 5/8 ( 6 10/16)
• SEK 7 1/4 ( 7 2/8) 7 1/8
• Why is the lending rate higher than the borrowing
  rate? The trick is these are the banks rates,
  and it lends to you at a higher rate than it will
  pay you for your deposits, its borrowing from you.

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Are There Profit Possibilities?

• Covered Interest Parity requires
• S/F3 (1 iusd,3) / (1 isek,3)
• With CIP, no profit opportunities from covered
  interest arbitrage.
• To see if there are opportunities, compare
• S/F3 with (1 iusd,3) / (1 isek,3).
• Often initial comparison is an approximation
  with mid points.
• S/F3 ? 9.120105 / 9.16355 mid-points ratio
  0.9952589
  
• (1 iusd,3)/(1 isek,3) ? 1 (6 21/ 32) /
  400/1 (7 3/16) / 400 mid-points ratio 1
  (6.65625) / 400 / 1 (7.1875) / 400
  1.0166406 / 1.0179688 0.9986952.
• Approximately, S/F3 lt (1 iusd,3) / (1
  isek,3).