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Currency Exchange Arbitrage Profit

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Suppose that six-month interest rates (annualized) in Japan and the United States are 7 percent and 9 percent, respectively. If the spot rate is ¥142:$1 and the ninety-day forward rate is ¥139:$1 and the 180 day forward rate is: ¥152:$1.

Assuming no transaction costs, what would be your arbitrage profit per dollar or dollar-equivalent borrowed?

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Solution Summary

The solution shows how to use the spot rate and forward rate to calculate the arbitrage profit in a situation that is applicable.

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Borrow Yen 142 (equivalent of $1) today. Invest Yen in Japan @ 7% for 90 days. Enter into forward agreement (90 day forward) to sell Yen and forward agreement to purchase Yen in 180 ...

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