Assume that the 180-day interest rate is 1% and 3%, respectively in the U.S. and Japan. Also, the spot rate and 180-day forward rate are equivalent at 120 yen per one U.S. dollar ($.008333 per one Japanese yen). As a trader for a commercial bank with $1,000,000 to invest, could earn a risk-free return by engaging in covered interest arbitrage? Be sure to show your calculations.
I have no idea what to do???
If the spot rate and 180-day forward rate are the same at 1USD= 120Yen, but the 180-day interest rates are different, the trader can invest to arbitrage.
First, at the beginning, exchange the $1,000,000 into JPY, ...