Question

One-year interest rates are currently at 9% for New Zealand and 4% for Australia. The spot rate is A$0.88/NZ$, while the 1-year forward rate is A$0.88/NZ$. Which of the following correctly describes a profitable arbitrage opportunity?

	A.	An Australian investor invests in New Zealand securities while agreeing to sell AU$ forward.
	B.	An Australian investor invests in New Zealand securities while agreeing to sell NZ$ forward.
	C.	A New Zealand investor invests in Australian securities while agreeing to sell NZ$ forward.
	D.	There is not enough information to answer the question.
	E.	None of the options.

Answer 1

Answer : B. An Australian investor invests in New Zealand securities while agreeing to sell NZ$ forward

The interest rate is higher in New Zealand @ 9% than in Australia, which is @ 4%

Hence, the investor will borrow in Australia at a lower rate and invest in New Zealand at a higher rate

After 1 year, the investor will want to convert the NZ$ into A$, hence the investor will enter into a forward contract to sell NZ$ after 1 year and buy A$ (to sell NZ$ and buy A$)

Hence, the correct answer is B.