(a) On 1st July 2008, 3 months interest rate in US and Germany are 6.5 per cent and 4.5 per cent per annum respectively. The $/DM spot rate is 0.6560. What would be the forward rate for DM for delivery on 30th September 2008?
(b) In International Monetary Market an international forward bid on December, 15 for one euro ( € ) is $ 1.2816 at the same time the price of IMM € future for delivery on December, 15 is $ 1.2806. The contract size of Euro is € 62,500. How could the dealer use arbitrage in profit from this situation and how much profit is earned?
Solution:
According to IRP ( Interest Rate Parity )
F/S = (1+iA )/(1+iB )
F/0.6560 = 101625/1.01125
therefore F = 0.6560 x 1.01625 /1.01125 = 0.6592
(b) Buy € 62500 x 1.2806 = $ 80037.50
Sell € 62500 x 1.2816 = $ 80100.00
Profit $ 62.50
Alternatively if the market comes back together before December 15, the dealer could unwind his position ( by simultaneously buying € 62,500 forward and selling a futures contract. Both for delivery on December 15) and earn the same profit of $ 62.50.
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