Question

Suppose the spot $/Yen exchange rate is 0.008, the 1-year
continuously compounded dollar-

denominated rate is 5% and the 1-year continuously compounded
yen-denominated rate is 1%. Suppose

the 1-year forward exchange rate is 0.0084. Explain precisely
the transactions you could use (being

careful about currency of denomination) to make money with zero
initial investment and no risk. What

is such a strategy being referred to in the markets?

Answer #1

The strategy is the interest rate arbitrage.

Let's work with $100. You can execute the following transactions.

1. Borrow $100 for 1 year at 5%. Total principal + interest to be returned after 1 year = 100e^0.05 = $105.13

2. Convert 100 USD to Yen at $0.008 /yen. Total Yen = 12500

3. Invest 12500 Yen for one year at 1%. Total principal + interest to be received after 1 year = 12500e^0.01 = 12625.63 Yen

4. Enter into futures contract to sell 12625.63 Yen at $0.0084 per Yen.

After one year

1. You receive Yen 12625.63

2. Sell yen to receive USD, USD received = 12625.63*.0084 = $106.06

3. Pay USD loan with interest

Total profit = $106.06 - $105.13 = $0.93

This is interest rate arbitrage

Suppose the exchange rate is $1.23/C$, the Canadian
dollar-denominated continuously compounded interest rate is 8%, the
U.S. dollar-denominated continuously compounded interest rate is
5%, and the price of a 1-year $1.25-strike European call on the
Canadian dollar is $0.0974. What is the value of a 1-year
$1.25-strike European put on the Canadian dollar?
a.
$0.1361
b.
$0.0813
c.
$0.1510
d.
$0.1174
e.
$0.1617

Suppose the spot exchange rate between the United States and the
United Kingdom is $1.73/£. The continuously compounded interest
rate in the U.S. is 8%, while the continuously compounded British
pound-denominated interest rate is 3%. Suppose you observe a 9
-month forward exchange rate of $1.99/£. What
transactions could you undertake to make money with zero initial
investment and no risk? Please work and show work. Thank you.

Suppose the exchange rate is $1.29/Fr, the Swiss
franc-denominated continuously compounded interest rate is 7%, the
U.S. dollar-denominated continuously compounded interest rate is
5%, and the exchange rate volatility is 24%. What is the
Black-Scholes value of a 3-month $1.30-strike European call on the
Swiss franc?
Correct answer is $.0533
Please answer by hand, no excel.
Thank you!

3) Suppose that the spot exchange rate S(¥/€) between the yen
and the euro is currently
¥110/€, the 1-year euro interest rate is 6% p.a., and the 1-year
yen interest rate is 3% p.a.
Which of the following statements is MOST likely to be true?
A. The high interest rate currency must sell at a forward premium
when priced in the low
interest rate currency to prevent covered interest arbitrage
Page 3 of 13
B. Real interest parity does not...

You are given:
(i) The spot exchange rate is 1.7 $/ £
(ii) The continuously compounded risk-free rate in dollars in
6.3%
(iii) The continuously compounded risk-free rate in pounds
sterling is 3.4%
(iv) a 6-month dollar-denominated European put option on pounds
with a strike of 1.7 $ /£ costs $0.04
(Question 6)
For conditions in Problem 5, determine the premium in pounds of
a 6-month denominated European put option on dollars with a strike
of 1/1.7 £/$.

Suppose the exchange rate is $1.54/£, the British
pound-denominated continuously compounded interest rate is 2%, the
U.S. dollar-denominated continuously compounded interest rate is
5%, and the price of a 6-month $1.60-strike European call on the
British pound is $0.1614. What is the value of a 6-month
$1.60-strike European put on the British pound? Answers: a. $0.2024
b. $0.1972(Correct answer) c. $0.1797 d.
$0.2435 e. $0.2214. Please show all your work, thank you.

Suppose the 6-month risk free spot rate in HKD is 1%
continuously compounded, and the 6-month risk free rate in NZD is
3% continuously compounded. The current exchange rate is 5
HKD/NZD.
a. Suppose again that our usual assumptions hold, i.e., no
constraints or other frictions. Suppose you can enter a forward
contract to buy or sell NZD 1 for HKD 5. Is there an arbitrage? If
yes, describe an arbitrage strategy. If no, briefly explain why
not.
b. Suppose...

Suppose that the euro exchange rate is $1.15/euro. The
continuously compounded dollar interest rate is at 3% and the
continuously compounded euro interest rate is at 2%. Suppose that
you borrow euros and lend dollars for 1 year, without using futures
for hedging, and your initial cash flow is zero.
(a) At what exchange rate in 1 year will you break even on this
position?
(b) If the exchange rate in 1 year is $1.20, what is your profit
(per...

Assume that the 1 year forward exchange rate is 100 yen for 1 US
dollar. Interest rate in dollars is 1 percent with annual
compounding. Interest rate in yen is 0.3 percent with annual
compounding. What is the spot exchange rate. PLEASE SHOW FORMULA
AND CLEAR CALCULATION

The spot rate of exchange of Japanese yen for US dollars is
currently 100 yen per dollar but the one year forward rate is 101
yen per dollar. Determine the yield on a one year zero coupon US
government security if the corresponding yield on a Japanese
government security is 2%.If the yield on a one-year zero-coupon US
government security was higher than what you calculated, how would
you exploit this arbitrage opportunity?

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