Question

The spot price for foreign currency in Australia is $0.6873/A$. The three month forward rate is $0.7117/A$. The three month interest rate for risk-free bonds is 8.5% p.a. in Australia and 5.5% p.a. in the U.S. Using the above rates, can you engage in a covered interest rate arbitrage as an American investor? Use either $100,000 or A$100,000 as the notational amount.

Answer 1

according to interest rate parity therom the currency with higher interst rate will sell in discount in futures market to cancel the arbitrage oppurtunity

here aud has hifger interest rate so aud shall be in discount in forward market

arbitage free price is = spot rate *(1+au rate )/(1+us rate)

arbitration process is borrow aud and invested usd securities and sell aud in futures market

arbitrage profit is 2844.46(aud)(calculation shown in work book)