Question

Use the following forward​ bid-ask, and interest rates for of AUD and USD,

Spot rate in AUD/USD: 1.2010-16

180-day forward rate in AUD/USD: 1.2231-39

The annual interest rates for AUD (lending or borrowing): 4%, 5%; for USD: 2%, 3%

Assume a year has 360 days, to answer:

1. Find the mid rates of these rates and use PPP to explain if:
   1. the 180 days forward rate > expected 180 days spot rate
   2. an investor can make profit by investing or borrowing USD
2. Use the spreads in the forward rates, spot rates, and interest rates to justify if:
   1. an investor can make profit by investing or borrowing USD
   2. an investor can make profit by investing or borrowing AUD
   3. Which one should be the major reason for an investor can't earn a profit?
      1. Choose one: liquidity is too low, fees are too high, cost of transaction is too high, currencies are fairly priced

Please show the working, thank you.

Answer 1

In the given case arbitrage oppurtunity arises due to difference in Theoritical price and actual price and Gain arises when a person borrows in AUD and invest in USD and the amount of the gain will be 367 AUD

The major reason an investor cant make a profit is due to cost of transactions and in real scenario due to high cost of transactions arbitrage profit may turn into losses.