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Calculate the one-year bond equivalent yield

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The treasurer of a middle market, import-export company has approached you for advice on how to best invest some of the firm's short-term cash balances. The company, which has been a client of the bank that employs you for a few years, has $250,000 that it is able to commit for a one-year holding period. The treasurer is currently considering twoalternatives: (1) invest all the funds in a one-year U.S. Treasury bill offering a bond equivalent yield of 4.25 percent, and (2) invest all the funds in a Swiss government secu-rity over the same horizon, locking in the spot and forward currency exchanges in the FX market. A quick call to the bank's FX desk gives you the following two-way currency exchange quotes.

Swiss Francs per U.S. Dollar

Spot 1-year CHF futures

1.5035 - U.S. Dollar per Swiss Franc (CHF)

0.6651 0.6586

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 5.50 percent, which strategy would leave the treasurer with the greatest return after one year?

c. Describe the transactions that an arbitrageur could use to take advantage of this apparent mispricing, and calculate what the profit would be for a $250,000 transaction.

Reference no: EM132715418

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