Availability of arbitrage opportunity and was to exploit it.

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Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

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Suppose the current exchange rate between the US dollar (USD) and the euro (EUR) is 1 USD = 0.85 EUR. Additionally, assume that the expected rate of return on US assets is 8% and the purchasing price of a US asset is $ 100. Calculate the expected rate of return on this US asset in terms of euros. [5] How does the ability of international investors to quickly and easily switch between domestic and foreign assets impact the relationship between exchange rates and asset prices, particularly in terms of expected rates of return?

The one-year interest rate in a European and a Mexican bank is 1% and 12% respectively. The spot exchange rate is EMX$/€ = 18.67 while the one -year forward exchange rate offered by the European bank is F€/MX$ = 0.05. i. Is there an opportunity for arbitrage? Calculate the interest forward exchange rate that eliminates it. ii. What steps would someone take to make an arbitrage profit, and how would he profit if he must borrow 1,000€ from a European bank?

Suppose the spot and six-month forward rates on the Norwegian krone are Kr 5.77 and Kr 5.92, respectively. The annual risk-free rate in the United States is 3.57 percent, and the annual risk-free rate in Norway is 5.27 percent. What would the six-month forward rate need to be on the Norweigan krone to prevent arbitrage?

Answer 2

Question

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

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Answer 3

Question

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

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Answer 4

Question

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

Expert Solution & Answer

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Answer 5

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

Answer 6

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

Answer 7

Chapter 31, Problem 10QP

a.

Summary Introduction

To explain: Availability of arbitrage opportunity and was to exploit it.

Answer 8

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

Answer 9

b.

Summary Introduction

To calculate: six month forward rate to prevent arbitrage.

Answer 10

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Answer 11

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Answer 13

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Availability of arbitrage opportunity and was to exploit it.

Solution Summary: The author explains the calculation of the arbitrage opportunity. The forward premium is too high.

Concept explainers

To explain: Availability of arbitrage opportunity and was to exploit it.

To calculate: six month forward rate to prevent arbitrage.

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Chapter 31 Solutions