In: Finance
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1.If the current spot and forward prices of a foreign currency are the same but interest rates are different, what would happen immediately and in the longer term?
2, What risks cannot be covered by arbitrage?
1. If the spot and the forward prices of the foreign currency as same but the interest rates are different the price of the dollar will immediately fault and will Keep Falling In the longer Run hence it shall not be useful or profitable for a person to invest in it the former treat and the spot rate are different prices for different contracts the forward rate is the settlement price of the forward contract by the spot rate is the settlement price of the spot contract a spot contract is a contract that involves the purchase or sale of a commodity security of currency for immediate delivery and payment on the spot date which is normally 2 business days after the trade date the spot rate and the spot price is the current price of the acid coated for the immediate settlement of the spot contract
2. Why called arbitrage conversion should not be constructed as trade that never have any risk nevertheless after identifying some major risk factor has some important steps in reducing these factors
Difference difference as a source of potential profit for the conversion strategy and cost of reversal strategy 6 dividend are never guaranteed the strategic cannot control the risk factor unless a policy of avoiding dividend paying stocks is adopted obviously why not applying convergence and reversals to dividend paying stocks there is no risk of conversion strategy
Early assignment if there is an early assignment resulting in the long stock position in the conversion been removed no dividend will be earned and a conversion strategy dependent on earning that dividend may experience a loss if the conversion was put on at exactly break even then The Lost will be equal to carry cost which could be significant depending on when the early exercise occurs .
interest rates there are no carry cost for several strategist instead in their profit calculation reversion strategy is depend on the interest paid on credit balances the best way to minimise the risk is to minimise the dependence on interest earned by the profitability of the strategies the interest earned Falls it will reduce profit but may not eliminate it another approach might be to invest in the interest bearing instruments
Expiration date on 1 last issue is the expiration date level of prices for the stock position in either a conversion or reversal if the price is well about the short call in the conversion it is not an issue as the call is Deep in the money and will automatically the exercise does taking away the Long stock position mean by the long put expires out the money this is also not an issue if the call is out of the money and put in the money the put will be exercised and this removes the stock position