Evaluating Arbitrage Opportunities and Profits
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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.
What arbitrage opportunity do these figures present?
And assuming no transaction costs, what would be the arbitrage profit per dollar or dollar-equivalent borrowed?
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Solution Summary
This solution provides step-by-step equations for finding arbitrage opportunity and arbitrage profits.
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For simplicity, let's assume that there is continuous compounding. Given these values the following arbitrage opportunity exists:
- Using the 180-day forward contract, agree to sell $1 in exchange for ¥152 180 days from now
- Borrow ...
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