Question

Suppose you have $10,000,000 or equivalent JPY. Consider the following information.

Assumptions	Value
Arbitrage funds available	$10,000,000
Spot rate (¥/$)	110
1 year forward rate (¥/$)	95
1 year U.S. dollar interest rate	4.00%
1 year Japanese yen interest rate	2.00%

Given the information above, how much arbitrage gains can be produced?

a)Arbitrage is not possible

b)USD1,410,526.32 (Gain)

c)JPY1,410,526.32 (Gain)

d)JPY134,000,000 (Gain)

e)- JPY 134,000,000 (Loss)

Answer 1

Interest rate parity:

As per Interest rate parity the difference in spot fate and forward rate exits due to differences in interest rate between two countries.

F/S = (1+ra)/(1+rb)
F= forward rate
S = spot rate.
ra = interest rate of price currency.
rb= interest rate of base currency.

If the above equation does not hold good then there is a chance of Arbitrage.

Arbitrage gain is $1,410,526.32

1.08 ; As pes IRP 95 vocitomb ! do 18.10% (should be) ros = 4%. (Actual) Borrow in USD: @ 4%. out how at maturity = 10,000,000 (1.00) = $ 10,400,000+4) a) Convent spot in ² 10,000,000 x 110 - 1100,ovo, ooo 6) Sell forward @ 95 c) Invest in & @ 2%, INflow in Fis 6100,000,000 (1.02) - 1,122,000, oro d) Convent at forward rate as pes b. (954/6) 1122,000, on 95 - ), 810, 526. 32 ) - ARBITRAGE GAIN= B - A = $1,410, 526.316 GAIN)