Respuesta :
Answer:
Spot x (1+domestic interest rate)/(1+foreign interest rate)=Forward rate
1.12*(1+0.05)/(1+0.035)=1.136
The forward rate should be $1.136/€ but is $1.16/€ so we have an arbitrage opportunity.
Because we believe that $ is being undervalued and € is over valued (one euro should be have a forward rate of $1.136/€ but has a rate of $1.16/€ )
We will borrow 1,000,000 at a 5% interest rate which means that at the end of the year we will have to pay = $1,050,000, this will be our negative cash flow.
We will then buy 1,000,000/1.12=€ 892,857 and Earn an interest of 3.5% on the Euros. At the end of the year we will get payed 924,107. This will be our positive cash flow. At the start of the year we will get into a forward contract in which we will sell the €924,107 for $1,071,964(924,107*1,16).Because the forward rate is $1,16/€ we will get 1.16 dollars for every euro.
At the end of the year we will have $1,071,964 from our forward contract and will have to pay 1,050,000 as our loan payment so we will be left with (1,071,964-1,050,000)= $21,964
D. $21,964.29 will be our net cash flow from this Arbitrage opportunity.
Explanation:
