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    Arbitrage with Forward and Option Contracts

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    Suppose that the Euro-USD spot and forward exchange rates are as follows:
    Spot 1.34
    90-day forward 1.3380
    180-day forward 1.3348

    What opportunity is open to an arbitrageur when a 180-day European call option to buy 1 Euro for $1.3083 costs $0.02 per Euro? Assume the size of forward and options contracts to be 1,000,000 Euros each. Ignore borrowing costs.

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    Solution Preview

    Sell a forward contract to deliver 1,000,000 Euros 180 days from now at the exchange rate ...

    Solution Summary

    This solution analyzes the arbitrage opportunity given forward and call option contracts.