Suppose You Observe the Following 1-Year Interest Rates, Spot Exchange

question 8

Multiple Choice

Suppose you observe the following 1-year interest rates, spot exchange rates and futures prices. Futures contracts are available on €10,000. How much risk-free arbitrage profit could you make on 1 contract at maturity from this mispricing?

• A)$159.22
• B)$153.10
• C)$439.42
• D)None of the above The futures price of $1.48/€ is above the IRP futures price of $1.4641/€, so we want to sell . To hedge, we borrow $14,077.67 today at 4%, convert to euro at the spot rate of $1.45/€, invest at 3%. At maturity, our investment matures and pays €10,000, which we sell for $14,800, and then we repay our dollar borrowing with $14,640.78. Our risk-free profit = $159.22 = $14,800 - $14,640.78.

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