Suppose That the Two-Months Interest Rate Is 6

question 14

Essay

Suppose that the two-months interest rate is 6.0 percent per annum in the United States and 7.0 percent per annum in Germany,and that the spot exchange rate is $1.12/€ and the forward exchange rate,with two-months maturity,is $1.10/€.Assume that an arbitrager can borrow up to $1,000,000 or €892,857.
a)What kind of arbitrage is possible?
b)Determine the arbitrage profit that can be made.
c)What would the forward rate have to be so that there would be no arbitrage opportunity?

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Definitions:

Elastic

A description of a situation in which the supply or demand for a product is highly responsive to changes in price, indicating sensitivity in the quantity supplied or demanded.

Monopolistically Competitive

Refers to a market structure where many firms sell products that are similar but not identical, allowing for some degree of market power.

Purely Competitive

A market scenario where the selling price of products is determined by the overall supply and demand, with numerous sellers and homogeneous products.

Elastic

Describes a condition in economics where the demand or supply for a product is sensitive to changes in price, leading to significant changes in quantity demanded or supplied.