A foreign exchange arbitrageur notices that the Japanese yen to U.S. dollar spot ex- change rate is JPY108 per USD (i.e. USD:JPY = 108) and the three-month forward exchange rate is JPY107.30 per USD (i.e. USD:JPY = 107.3). The three-month USD interest rate is 1.3% percent per annum and the three-month JPY interest rate is 0.3% percent per annum.

1. Interest parity does not hold. With the aid of appropriate calculations, explain why.

(2 marks)

2. Explain why an arbitrage opportunity exists. You have USD1 000 000 to work with, calculate the arbitrage profit be in dollars? (13 marks)

3. Today is 1 August 2022. Illustrate how a Taiwanese Arbitrageur can earn risk-free profit with an attempt to earn higher nominal rate in South Africa based on the following quotation from Bank of Taiwan. Assume a 12-month investment horizon. (10 marks)

Bid Ask

S₀ (NT/R): 3.95 4.05

F_12/12 (NT/R): 3.80 3.96

Invest Borrow

Taiwan 1.6% p.a. 2.6%p.a.

South Africa 10% 18%

d. Today is 1 August 2008. Illustrate how a South African Arbitrageur can earn risk-free profit with an attempt to earn NT Forward Premium based on the following quotation from Bank of Taiwan. Assume a 12-month investment horizon. (10 marks)

Bid Ask

S₀ (NT/R): 3.95 4.05

F_12/12 (NT/R): 3.32 3.38

Invest Borrow

Taiwan 1.6% p.a. 2.6%p.a.

South Africa 10% 18%