Question

1. A friend of yours tells you that in Japan a specific Japanese treasury note matures for $1000 in two years can be bought or sold for $925. What is the annualized risk-free rate in this example? You happen to notice the same security can be purchased or sold domestically for $945,

how do you arbitrage this position?

How many times should you make this trade?

How likely is it that your friend’s information is current and correct?

Answer 1

Future Value = $1000

Current Price = Present Value = $925

So, => => r =3.975%

Therefore, annualized risk free return = 3.975%

1. To arbitrage this position, we can buy the treasury note in Japan for $925 and sell it domestically for $945, making a profit of $20

2. We should make this trade as long as price of treasury note in Japan is lesser than the price of treasury note domestically

3. It is not very likely that the information is correct because markets are usually efficient and if there was an arbitrage opportunity, it would have already been exploited by other arbitrage traders.