Suppose the same information as in question 3. Suppose a dealer quotes a one year forward...

Suppose the same information as in question 3. Suppose a dealer quotes a one year forward price of 350 dollars per euro. Describe the transactions you would undertake to engage in an arbitrage.

question 3 below

Suppose the current exchange rate is 320 dollars per euro, the continuously compounded dollar interest rate is 3%, and the continuously compounded Euro interest rate is 1%. What is the one year Euro forward rate?

Expert Solution


Forward rate= USD per EURO * E^0.03/e^0.01

Forward rate=	=320*e^0.03/e^0.01
Per EURO	326.46

Since given forward rate is 350, we can see that some arbitrage opportunity is available

So the funds available are invested in EURO, assumed, 1,000,000 USD are loand from US and invested in EURO
Equivelent EURO	=1000000/320
	3,125.00

This is invested in EURO so amount after 1 year	=3125*exp(0.01)
	3,156.41

Amount converted back to USD	=3156.41*350
	$ 1,104,742.37

Amount payable in US after 1 year	=1000000*exp(0.03)
	$ 1,030,454.53

So this way there will be gain	1104742.37-1030454.53
So this way there will be gain	$ 74,287.84

jeff jeffy answered 1 year ago

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