Question

The spot rate for the Swiss Franc is $1.05/CHF. A dealer quotes $1.0475/CHF for the 90-day forward rate.
If the interest rate in the US is 4% and the interest rate in Swizerland is 8%, can you arbitrage?
Show the details. Use 100,000 as the notional amount.

a. At what forward rate will it not be possible to arbitrage?

c.

Continuing with the previous question, If the inflation rate in the US was 7%
and 2% in Croatia, what is the real rate of appreciation or depreciation of th dollar?
Using real exchange rates, which country's exports will suffer?

Answer 1

A) spot rate is 1.05

Quoted forward rate is 1.0475

Given us interest rate is 4% for 90 days = 1%

Given swiss interest rate is 8% for 90 days is 2%

According to interest rate parity therom the currency with high interest rate will sell in discount in futures market to cancel the arbitrage

So swiss franc will sell in discount

Arbitrage free price = 1.05×(1.01)/(1.02) = 1.0397

So at forward rate of 1.0397 there is no arbitrage

As theoretical futures is less than actual price arbitrage exists

Suppose we have 100000 dollars

We sell swiss in futures and invest in Swiss securities

Liability on dollars is = 100000×1.01 = 101000

We receive = 100000×1.05×1.02/1.0475 =102243 dollars

Profit is 1243 dollars

C) inflation in us 7%

Inflation in Croatia is 2%

So to match purchasing power us dollar will depreciate and Croatia will appreciate

Percentage change is = 1.07/1.02 -1 = 4.9%

So us dollar will depreciate by 4.9%

As Croatian currecy is appreciated it's exporters is going to suffer