Question

You have the following market data. Spot price for the Mexican Peso is $0.054 per Peso. Futures price is $0.069 per Peso on a contract that expires in one month. U.S. dollar LIBOR for four months is a continously compounded rate of 2.7% per annum. British LIBOR for four months is a continuously compounded rate of 2.45% per annum. The contract size is 500,000 Mexican Pesos. What is the total net profit if you execute the arbitrage strategy with one futures contract?

Answer 1

The no arbitrage forward price for MXN based on the interest rate differential = 0.054 * e^(0.027-0.0245)*(1/4)

= 0.05403

Since the MXN/USD futures contract is trading at a rate higher than its theoretical price, one can borrow USD (@2.7%), Sell USD in spot and Buy MXN (@0.054)and enter into a forward contract to sell MXN and Buy USD (@0.069) and lend the MXN (2.45%)

This arbitrage is known as cash and carry arbitrage.

The resulting profit would be: 500000 * (0.069-0.05403) = USD 7483.12