Suppose that the spot exchange rate between the Japanese Yen and the US Dollar is JPY/USD 106.5. The forward exchange

rate for 3 months is JPY/USD 105.5 and the 3 month interest rates are 1.05% p.a. in Japan and 1.25% p.a. in theUS (continuously compounded).

1)Are there any arbitrage opportunities? If yes, how would you make a risk free profit?

2) Suppose a Japanese firm enter into a forward contract at the quoted forward exchange rate to purchase 1 million USD in three months. What is the value of this contract to the company?

(Please express your result in JPY.)