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

Spot Dollar/Yen Exchange Rate 113.68 Japanese Yen/$

3-month Forward Dollar/Yen Rate 113.11 Japanese Yen/$

3-month US (dollar) Risk-free Interest Rate 3.50%

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 (yen) interest rate (annualized, c.c.) be

for there to be no arbitrage?

(b) Suppose that the annualized, continuously compounded 3-month Yen

interest rate is 1.0%. Describe exactly what transactions you would

undertake at these prices/rates to lock in an arbitrage profit.