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 Summary
This solution analyzes the arbitrage opportunity given forward and call option contracts.
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Sell a forward contract to deliver 1,000,000 Euros 180 days from now at the exchange rate ...
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