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Derivative Securities Section 1 Suppose that the 1-year interest rates in the United States and Australia are 2% and 5% (continuous compounding), respectively. The spot

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Derivative Securities

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Section 1 Suppose that the 1-year interest rates in the United States and Australia are 2% and 5% (continuous compounding), respectively. The spot exchange rate is 0.70 USD per AUD. A) What is the 1-year forward exchange rate that excludes arbitrage opportunities? (1 mark) B) Suppose 1-year forward exchange rate is also 0.70 USD per AUD. Explain in detail how to generate 1000 USD arbitrage profit (small rounding error is allowed) at the end of 1 year. (4 marks)

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