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Interest rates & exchange rates

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Suppose that the riskfree interest rates in Australia and Japan are 6% p.a. and 2% p.a., respectively. The AUD/JPY spot rate is 70.00 and the AUD/JPY oneyear forward rate is 68.00. Based on this situation do any arbitrage opportunities exist? If so, explain what these arbitrage opportunities are and outline the steps you would take to exploit them. Calculate the arbitrage profit that you could earn on AUD 1,000,000, or its JPY equivalent. If no arbitrage opportunities exist then explain why they do not exist. With all calculations.

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Solution Summary

This solution helps with problems regarding interest rates and exchange rates. Step by step calculations are given.

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Implied forward rate, F1 = 70.00(1.02/1.06) = 67.36.
Invest in Australia for one year: $1.06.
Invest in Japan for one year; use ...

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