An arbitrage opportunity and design trading to exploit

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Reference no: EM131935734

Suppose the one-year interest rate is 4 percent in the domestic economy, and 6 percent in the foreign economy. The current spot exchange rate is 1:1 between domestic and foreign currency. There are future contracts available in the domestic economy that allow contract holder to lock in an exchange rate one year from today at the rate of 0.8, i.e., 0.8 foreign dollars per one domestic dollar. The cost of such a contract is 0.2 dollars per 1 dollar face value. Show that there is an arbitrage opportunity and design a trading to exploit it.

Reference no: EM131935734

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