Suppose the Swiss national bank wants to fix the Swiss franc at a value with respect to the euro which is below the market equilibrium value of the Swiss franc.

S (EUR/CHF) PEG is less than S (EUR/CHF) Market

You believe that the Swiss franc peg against the euro is unsustainable. You expect the Swiss national bank to give up the peg within one month and the Swiss franc to greatly appreciate then. (Give short answer and graphs/formulas wherever possible-No calculations)

(a) Which zero-investment trading strategy based on money market deposits and loans (denominated in Swiss franc and euro) would you implement? List the positions and write down the payoff of your strategy denominated in Swiss franc in one month.

(b) How can you implement this speculative trade with a one-month forward contract? Show that the forward based strategy is profitable if and only if the money-market strategy from above question is profitable

Answer rating: 100% (QA)

a We would borrow Swiss francs and use the proceeds to buy euros ... View the full answer