On May 17 Shen an American investor decided to buy three

Last updated: 11/6/2023

On May 17 Shen an American investor decided to buy three month Treasury bills He found that the per annum interest rate on three month Treasury bills is 8 00 in New York and 12 00 in London Great Britain Based on this information and assuming that tax costs and other transaction costs are negligible in the two countries it is in Shen s best interest to purchase three month Treasury bills in because it allows him to earn more for the three months On May 17 the spot rate for the pound was 1 510 and the selling price of the three month forward pound was 1 508 At that time Shen chose to ignore this difference in exchange rates In three months however the spot rate for the pound fell to 1 450 per pound When Shen converted the investment proceeds back into U S dollars his actual return on investment was As a result of this transaction Shen realizes that there is great uncertainty about how many dollars he will receive when the Treasury bills mature So he decides to adjust his investment strategy to eliminate this uncertainty What should Shen s strategy be the next time he considers investing in Treasury bills Avoid investment in foreign institutions T Contract in the forward market to sell the foreign currency in the amount of the proceeds from the investment Exchange half of the anticipated proceeds of the investment for domestic currency Had Shen used the covered interest arbitrage strategy on May 17 his net return on investment relative to purchasing the U S Treasury bills in British three month Treasury bills would be Note Assume that the cost of obtaining the cover is zero