Will an Arbitrageur Facing the Following Prices Be Able to Make

question 70

Multiple Choice

Will an arbitrageur facing the following prices be able to make money? $$\begin{array} { c c c c c } & \text { Borrowing } & \text { Lending } & \text { Bid } & \text { Ask } \\€ & 5 \% & 4.5 \% & \text { Spot } \$ 1.00 = € 1.00 & \$ 1.01 = € 1.00 \\€ & 6 \% & 5.5 \% & \text { Forward } \$ 0.99 = € 1.00 & \$ 1.00 = € 1.00\end{array}$$

• A)Yes,borrow $1,000 at 5 percent; trade for € at the ask spot rate $1.01 = €1.00; Invest €990.10 at 5.5 percent; hedge this with a forward contract on €1,044.55 at $0.99 = €1.00; receive $1.034.11.
• B)Yes,borrow €1,000 at 6 percent; trade for $ at the bid spot rate $1.00 = €1.00; invest $1,000 at 4.5 percent; hedge this with a forward contract on €1,045 at $1.00 = €1.00.
• C)No; the transactions costs are too high.
• D)none of the options

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Definitions:

Straight-Line Methods

Straight-line methods are used in accounting to allocate the cost of an asset evenly over its useful life for the purposes of depreciation.