Question 4. (This question has two parts: I and II)

Part I.

On 25 July of a particular year, an American firm decided to close its account at an Australian bank on 28 August. The firm is expected to have 4 million Australian dollars in the account at the time of the withdrawal. It would then covert the funds to U.S. dollars and transfer them to a New York bank. The September Australian dollar futures contract was priced at $0.7571. Determine the outcome of a futures hedge if on 28th August the spot rate was $0.7237 and the futures rate was $0.7250. All prices are in U.S. dollars per Australian dollar. The Australian dollar futures contract covers 100,000 Australian dollars.

Part II.

In a particular year, the spot exchange rate between the Canadian dollar and U.S. dollar was $0.7554 (per Canadian collar). Interest rates in the U.S. and Canada were 1.5 percent and 1.25 percent per annum, respectively, with continuous compounding. The three-month forward exchange rate was $0.7675, which creates an arbitrage opportunity. Propose one possible strategy to take advantage of this situation and show your possible profit.