The risk-free one-year interest rate in the Swiss Franc (CHF) is 1.5%, while the risk-free one-year interest rate in the Euro (EUR) is 3.5%. The current spot exchange rate is CHF 1.2000 = 1 EUR and both currencies are traded in an open market without transaction costs.

(a) Your Swiss client (whose wealth and profits are in Swiss Francs) has an obligation of EUR 10,000, six months from now. How can your client construct a money-market hedge, to fund this obligation without exchange-rate risk? Assume your client can borrow and lend at the risk-free rate in both currencies. Show that the strategy you propose is costless today and allows your client to meet his obligation at a fixed exchange rate that is known today. Find that fixed exchange rate.

(b) You spot a six-month Euro forward in the market that has a forward exchange rate of CHF 1.2100 per EUR. How can you make an arbitrage profit for your own firm in this case? Ignore your clients obligation from the previous part, and assume that your firm can also borrow and lend at the risk-free rate in both currencies, as well as buy or sell the Euro forward.

(c) Which parity relationship is violated by the forward contract in part 2b?