You are running the FX trading desk at a large, high-grade investment bank. You have the following rates available to you:

Assume that there are no transaction costs, and that you can either buy or sell at these exchange rates. Also, the interest rates above are quoted in annualized, continuously-compounded form, and are the same for borrowing or lending

(a) What must the 3-month Japanese interest rate be, if there is no arbitrage?

(b) Suppose that the annualized, continuously compounded 3-month yen in- terest rate is 1.0%. What would you do? Provide precise details.

Spot Dollar/Yen Exchange Rate 3-month Forward Dollar/Yen Rate 1-month US dollar) Risk-free Interest Rate 3-month US dollar) Risk-free Interest Rate 120.44 Y/8 119.09 Y/8 5.50% 6.00%