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Parity Relationships and Arbitrage

9. You are an expatriate working for Bank America in Hong Kong, and observe the
following prices. Formulate an arbitrage strategy to profit from the situation.

? Swiss Franc per Dollar exchange rate is 1.30 spot and 1.35 for 180-day forward.
? Swiss interest rate is 6.00% compounded daily.
? U.S. stock market index is 1500 today.
? At today's level of the index, the average annual dividend yield on the stocks in the index is 3% (for simplicity, assume the dividends for your six-month holding period will all be paid at the end of 180 days).
? The U.S. stock market index 180-day futures price is 1490

Solution Preview

9. An arbitrage to take advantage of this involves the following steps:

a. Borrow CHF 1,300,000 at 6% compounded daily.

b. Convert it to $1,000,000 and invest in the stocks in the U.S. stock market index (a million dollars worth of ...

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