Question
You are given the following information: A US 3-year 0-coupon bond with FV = 104 USD is trading at a price of 100 USD. A
You are given the following information:
A US 3-year 0-coupon bond with FV = 104 USD is trading at a price of 100 USD.
A JPY 3-year 0-coupon bond with FV = 102 Yen is trading at a price of 100 Yen.
Assume there is no default risk. USDJPY 3-year forward exchange rate is equal to 110.
a) Assuming there is no arbitrage, what is the spot exchange rate for USDJPY at t = 0?
b) Suppose the USDJPY spot exchange rate were 1 lower than your answer to part b. Describe how you would create an arbitrage opportunity. Make sure to mention how much of each currency you are converting in the spot and forward market and how many units of each bond you are trading. Note: you are allowed to buy/short fractional units of the bonds.
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