Question 3 (40 points): Consider two markets; a local market and a foreign market. In both markets the rates are reported based on annual compounding. The 1-year spot rates are: RL=0.04 in the local market, and RF=0.08 in the foreign market. The spot exchange rate is F0=1.06 of the local currency per one unit of the foreign currency. A forward contract to deliver, in 1 year from the current time, one unit of the foreign currency, is written with a forward price of FF=? of the local currency per one unit of the foreign currency. (a) [20 points] Determine what the forward price FF should be by calculating the cost of delivering the foreign currency. Solution Question 3 (a) (b) [20 points] Assume now that the forward price is 1.2 (i.e. FF=1.2 and so, it is not what was found in (a)). This forward price is too high for the markets. Stipulate the actions needed to exploit the resulting arbitrage opportunity if you are allowed to borrow only in the local market and no more than 100 units of the local currency. You must stipulate the actions taken at each time, the net cash inflow at each time, and the arbitrage profit obtained.