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Question:
(a) With the help of illustrative and numerical examples differentiate fully speculation and arbitraging in the context of foreign exchange.
(b) Shirley, a trader in the foreign exchange department of Sanwa Bank, Singapore Office, specialises in arbitraging US$ against EURO. She observes the following rates at 9:10 am Singapore time:
Spot rate EURO 1.8200 = $1.000.
Three months forward rate - EURO 1.8000 = $1.000
Yamada can borrow or invest US$ for three months at 9.1% p.a or EURO for 3 months at 5% per annum.
Transaction costs to the above are $ 8000.
She is allowed to borrow $5 million or an equivalent amount in EURO
(i) How can Shirley make a risk free profit? Assuming she prefers to make her profit in dollars.
(ii) If the dollar 3-month interest rate should increase to 10.1% p.a, other conditions remaining the same, would she still make profit using the same strategy as she uses in your answer to part (a) above?
differentiate between allocative efficiency and pricing efficiency
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