# interest rate arbitrage, your way

If the forward exchange rate is \$0.045/yen and the fair forward exchange rate based on interest rate parity is 0.050/yen. Which of the following actions would be part of an interest rate arbitrage to profit from the misvaluation? a. Borrow 's today and sell the forward. b. Borrow yen today and buy the forward. c. Borrow yen today and sell the \$ forward. What’s your method for analyzing this?

Observed forward price of = 22.22 Yen Fair forward price of = 20 Yen Sell forward, and borrow Yen to buy spot. What is the correct answer?

good question, A? looks like Yen is undervalued and dollar is overvalued long yen and short dollar. short = borrow

How do other people analyze this?

B? forward is cheaper than its fair value.

I’m beginning to like this… answers so far: a, b, and c.

forward rate is \$0.045/yen irp rate is 0.05/yen forward rate undervalues dollar B) Borrow yen today and buy the forward.

I think it’s B, The forward \$ is undervalued, so you want to buy it.

They are both forward quotes. There is no spot.

b for me right now dollar is overvalued - sell it yen should be buying .05 but its only buying .045- undervalued - buy it

Still have my money on C, peeps

watch it be none of the above, lol

It is C. I haven’t yet gotten a hold of this very well. I’ll post the explanation in a minute.

DC Zanini Wrote: ------------------------------------------------------- > I think it’s B, > > The forward \$ is undervalued, so you want to buy > it. I’'m changing my answer to C after looking at it for about 5 minutes. Watch, it’ll be B

DC Zanini Wrote: ------------------------------------------------------- > DC Zanini Wrote: > -------------------------------------------------- > ----- > > I think it’s B, > > > > The forward \$ is undervalued, so you want to > buy > > it. > > > I’'m changing my answer to C after looking at it > for about 5 minutes. Watch, it’ll be B Nevermind. Dreary is too quick

You borrow 1 yen today and its worth 0.50 at end of period according to IRP. You can sell the forward and only owe \$0.45 and make a \$0.05 profit. So answer is C. Is that correct?

Forget my answer - I guess I got it right but for the wrong reason. I forgot about having to pay back the yen

Borrow yen at the risk-free rate in Japan and sell them spot, using the proceeds to purchase yen forward. Simultaneously, sell dollars forward and use the proceeds to purchase dollars on the spot market. The purchased dollars are then invested at the US risk-free interest rate. Could someone put some structure on how to go about these kinds of problems?

(accidental double post)