Question

assume annualized interest rates in the U.S. and the Euro area are 1% and 3%, respectively. One Euro is worth $1.20 and the one-year forward rate for the Euro is $1.17669.

a.) what is the expected exchange rate in one year under no arbitrage?

b.) Is covered interest arbitrage profitable?

c.) You are a FX trader and forecast the euro to move $1.22 in one year. Would you buy or sell euros forward today? Why? Quantify your expected arbitrage profit.

d.) Your colleague disagrees with you. He expects the euro to love to $1.15 in one year. Should he buy or sell Euros forward today? Why? Quantify his expected arbitrage profit. One year later, the Euro is worth $1.17.

e.) Both you and your colleague traded against UIP, though in different directions. Did you make a profit or a loss on your trade? And your colleague? Why?

Answer 1

A) $ 1.45438

B) Yes

C) buying Euros

it's profitable forward rate

D) yes he buying a forward rate

after one year he gets $1.41802 @ rate $1.17

E) Both are getting profit because of the rate comparatively just a slight difference