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You observe that the EUR/HKD spot exchange rate (i.e., the price of 1 Euro in terms...

You observe that the EUR/HKD spot exchange rate (i.e., the price of 1 Euro in terms of Hong Kong Dollars) is 8.91 and the 1-year EUR/HKD forward exchange rate is quoted at 9.5.(Total 10 marks)

(a) Does an arbitrage opportunity exist given that the 1-year deposit rates in Hong Kong and Europe and are 2.5% and 0.5%, respectively?

(b) If so, outline an arbitrage strategy and explain step by step why your strategy yields risk-free profits.

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