The lending (deposit) and borrowing market rates for GBP loans are 0.5% and 0.625% for one year respectively, and 5.375% and 5.5% for EUR loans (all rates annualised). The spot GBP/EUR exchange rates are 1 ("buy GBP at") and 1.005 ("sell GBP at"). A trader quotes a one-year forward rate of -100 points (buys GBP at 0.99 and sells GBP at 0.955 respectively)

Explain in full detail why there is an arbitrage opportunity, the position that generates it and calculate the arbitrage profits. Eliminate it by changing (a) the GBP borrowing or lending rate the EUR borrowing or lending rate  the trader's forward rates. 

(iii) The 3-month interest rate is 1% in Mexico and 3% in Brazil (continuously compounded), while the spot price of the Mexican peso is 1.05 real.

 The price of a 3-month future is the same. Are there arbitrage opportunities? Explain in detail.

Answer rating: 100% (QA)

i Arbitrage opportunity First lets calculate the implied GBPEUR exchange rate from the deposit and borrowing rates GBP deposit rate 05 GBP borrowing rate 0625 EUR deposit rate 5375 EUR borrowing rate ... View the full answer