Youre a FX trader working in Japan. You have decided not to bear transaction foreign exchange risk. The required information is as follows:

	Bid	Ask
Spot rate (/$)	77.7011	77.7201
180-day Forward rate (/$)	77.6554	77.6814
Dollar interest rate % p.a.	4.98	5.02
Yen interest rate % p.a.	1.52	1.58

Required:

a. You are considering two alternative investments of 1,000,000 in the 180-day yen deposits or 180-day U.S. dollar deposits. Calculate the yen return for both deposits (domestic vs. foreign money market). You must show your workings with 4 decimal numbers on a step-by-step approach. (4 marks)

b. Which one provides the higher yen return in 180 days? (1 mark)

c. Based on the answers from (a) and (b), which arbitrage strategy should you take? i.e. inward or outward arbitrage? (1 mark)

d.

i) Using a box diagram that represents covered interest arbitrage (a rectangular arbitrage that we have drawn with arrows in the tutorials), demonstrate how you can make arbitrage profit with a step-by-step approach. You MUST choose the correct bid or ask price for each transaction. Please start with 1,000,000 units of currency and use 4 decimal points. (6 marks)

ii) What is the rate of return that you can make from the arbitrage profit? (1 mark)

Hint: There are nodes in each corner of the rectangular box. There are four arrows and each arrow indicates the steps required to show the process of arbitrage. Choose the correct direction (clockwise or anti-clockwise) of arrows to reflect the arbitrage strategy you have chosen in the question (c).