A good investor is also a good arbitrageur who keeps constant awareness on chances to make easy money. Suppose you observe the following exchange rates: S($/) = $1.3/. The one-year forward rate is F($/) = $1.35/. The risk-free interest rate in the U.S. is 5% and in Germany it is 2%. Suppose you can borrow up to 1,000,000 from the German money market or $1,300,000 from the U.S. money market. Devise the arbitrage strategy and calculate the maximum arbitrage profit that you can make from this situation. (Hint: first compute the synthesized dollar interest rate by investing in the euro money market)

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To devise the arbitrage strategy we need to compare the riskfree interest rates in both countries an... View the full answer