Foreign Currency Arbitrage: The spot exchange rate for converting one US dollar into an FD (a foreign dollar) is 8.32. The spot rate for converting one FD into USD is 0.1202 (= 1/8.32). A long FD forward contract obligates the holder to buy one FD in 9 months time at the rate 0.10 (USD per FD). Annual continuously compounded US interest rate is 1.0%. Annual continuously compounded foreign interest rate is 4.0%.

a) What is the fair forward price?

b) Given that fair forward price does not equal 0.10, propose a set of transactions that will produce an arbitrage. Fill in an arbitrage table (an example table is provided below) with your numerical values assuming that S_T = 0.09 at the end of nine months.

c) Repeat (b) but now provide the table assuming that S_T = 0.13.