current market price of Forward rate is :Yen=107, but according to PPP, forward rate is :yen=106, should we buy yen forward or should we sell yen forward? should we use cash and carry or reverse cash and carry? if we sell yen forward and buy yen, should we borrow USD or should we borrow yen to do arbitrage?
Buy Yen forward Yen is under priced and will appreciate soon , so buy now
how about the rest of questions?
- I would buy yen forward. 2. I may be wrong but this would be reverse cash and carry, correct me please. 3. In order to recognize a profit, I would borrow yen. I assumed the following: Spot rate: Yen100/ Yen one year interest rate: 6% one year interest rate: 0% Forward Contract rate (given): Yen107/$ I borrow Yen100 and would have to pay Yen106 in 1 year I sell the Yen at the spot rate and get $1 I give a loan and get $1 at the end of the year. I use the forward contract to buy Yen107 by selling $1. Profit = 107 - 106 = Yen1
Regarding 2. In general, when Forward price is Overpriced, you sell forward and buy the underlying in spot. You need cash to buy the underlying, so you borrow cash. This is Cash and Carry. And when Forward price is Underpriced, you buy forward and sell the underlying in spot. You get cash from selling the underlying and you invest that cash. This is Reverse Cash and Carry. In this case (currency forwards), both the underlying are currencies and they both yield interests. So, reverse or not is difficult to say, it could depend upon what is your domestic/book currency.
oh, no, Assuming I am US investor, I sell yen forward and buy yen spot, I lend yen, this is cash I already lend, thus cash and carry. I buy yen forward and sell yen, I borrow yen and this reverse cash
You are selling Yen in Spot market. You will receive US Dollars from selling those Yen. You LEND these USD at risk free rate. So, yes, for a US Investor, this is Reverse Cash and Carry. Another strategy for the same mispricing could be: USD Forward is Overpriced at 107. So you sell USD forward and buy USD Spot. You will need Yen to buy USD Spot. So, you BORROW Yen. So, for a Japanese investor, this becomes Cash and Carry. So, for Currency Forwards, depending upon which arbitrage strategy you follow will determine if it is Cash and Carry or Reverse Cash and Carry. I dont think being able to distinguish between Cash and Carry and Reverse Cash and Carry is important though.
what about this?
- A trader notices the following quotes: USD/JPY spot exchange rate 150.23, USD/JPY one-year forward exchange rate 143.59, one-year USD interest rate 5.4% p.a., and one-year JPY interest rate -0.25% p.a.
a. Ignoring transaction cost, does the (covered) interest rate parity hold?
b. Is there an arbitrage opportunity? If yes, what steps would be needed to make an arbitrage profit? Assuming that the trader is authorized to enter transactions with nominal amount equivalent up to 100 million USD for this purpose, and ignoring transaction cost, how much could the arbitrage profit be in USD?
c. Would the arbitrage opportunity still exist using bid/ask prices that are ±0.25 JPY below or above the mid exchange rates indicated above, and if the bid/ask deposit rates were ±0.15% below or above the mid depo rates given above?