CIA Problem

Arbitrage funds availabletoborrow:$1,000,000orforeign currency equivalent

Spot exchange rate (Y/$)110.50

1-month forward rate(Y/$)108.22

U.S. dollar 1-month interest rate perannum5.50%

Japanese 1-month interest rate perannum3.10%

SHOW ALL YOUR WORK!!!!!

1. Answer the following questions using the data above and be sure to label your answers A), B), and C):

A) Which currency is selling at a forward premium (no calculation is necessary)?

B) Show the arbitrage calculations for the above scenario by determining: 1) the true (equilibrium) forward rate and 2) indicate where you should invest by determining which currency is overvalued and which is undervalued.

C) Show all the steps and calculate the profit (assuming you borrow the funds for investment) from CIA.The BOX technique is unacceptable. (You should designate every currency in every transaction, timeline, etc. and be highly detailed. If you do not, you will lose points.)