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Question 4 (20 marks) a) Suppose the spot AUD/USD exchange rate is 0.63, the continuously compounded USDdenominated rate is 5% per annum and the continuously

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Question 4 (20 marks) a) Suppose the spot AUD/USD exchange rate is 0.63, the continuously compounded USDdenominated rate is 5% per annum and the continuously compounded AUD-denominated rate is 3% per annum. What is the 2.5-year forward AUD/USD exchange rate? And, suppose if the current forward price for buying USD in 2.5-year via a forward foreign exchange contract is 1.5625 AUD, explain precisely the transactions you could use to make a \$696 USD arbitrage profit today. (10 marks) b) Suppose the 3-month forward JPY/USD exchange rate is 0.0080, the volatility of exchange rate is 30% per annum and the continuously compounded JPY-denominated risk-free rate is 1% per annum. Compute the no-arbitrage price expressed in JPY for a put option that allows you to sell $10,000 USD at the price of 1,500,000 JPY in 3-month time. (6 marks) c) People argue that "potential credit risk, i.e. losses from defaults, on a currency swap are greater than on an interest rate swap". Do you agree with this statement? Explain your answers. (4 marks) Question 4 (20 marks) a) Suppose the spot AUD/USD exchange rate is 0.63, the continuously compounded USDdenominated rate is 5% per annum and the continuously compounded AUD-denominated rate is 3% per annum. What is the 2.5-year forward AUD/USD exchange rate? And, suppose if the current forward price for buying USD in 2.5-year via a forward foreign exchange contract is 1.5625 AUD, explain precisely the transactions you could use to make a \$696 USD arbitrage profit today. (10 marks) b) Suppose the 3-month forward JPY/USD exchange rate is 0.0080, the volatility of exchange rate is 30% per annum and the continuously compounded JPY-denominated risk-free rate is 1% per annum. Compute the no-arbitrage price expressed in JPY for a put option that allows you to sell $10,000 USD at the price of 1,500,000 JPY in 3-month time. (6 marks) c) People argue that "potential credit risk, i.e. losses from defaults, on a currency swap are greater than on an interest rate swap". Do you agree with this statement? Explain your answers. (4 marks)

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