Attached is a picture of my question the course is International Financial Manag

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Attached is a picture of my question the course is International Financial Management. Any help would be appreciated. The following bid and offer spot and 3-moath forward exchang Eure against the US. dollar (USD) e rates are shown for the Bid Offer Mid 1.02/Euro 0.995/Euro Euro spot 1.01/Euro 0.99/Euro 1.03/Euro 1.00/Euro 3-mo forward Also, the following offer and bid bank annualized interest rate, based on 3-month maturities, are shown for the Euro and USD. Annualized Annualized (in decimals) (in fractions) Three months monthsMid Bid or Three months offer Ca.bid(%) Offer 0.032 0.014 0.0325 0.0315 Euro U.S. Dollar 3 1/4. 3 5/3 /8 1 1/20.015 0.013 (a) Show the self-financing riskless covered interest arbitrage that s possible in this market, starting the analysis by borrowing 1 million units of the curreney to be borrowed. (Determine which currency to borrow by examining the relationship between the mid spot and forward exchange rates and the interest rates.)

Explanation / Answer

IRPT forward would be:

Forward rate = Spot rate * (1 + Domestic Interest) / (1 + Foreign Interest)

Forward rate (3 months) = 1.02 * (1+0.032) / (1+0.014)

Forward rate (3 months) = 1.038 / Euro

Quoted Forward rate for 3 months in market = 0.995 / Euro

The forward Euro rate is currently undervalued. Therefore, an arbitrageur would like to take advantage of this under valuation of the Forward Euro.

A covered Interest Arbitrage Strategy is:

                               

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