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Question $6$

The current EUR$/$USD spot exchange rate is $$1\mathrm{.}11($you need $$1\mathrm{.}11$ to buy el$,$ where

$e=$ euro$).$ The annual interest rate in the Eurozone, $r_e,$ is $3\%$ while the annual rate in the

US$,r_8,$ is $5\%($assume flat term structures$).$

$($a$)(")$ What should be the two$-$year EUR$/$USD forward exchange rate?

$($Write your final answers in dollars and round to two decimals: for instance, if the answer

is $$450\mathrm{.}355$ or $$450\mathrm{.}359,$ write $450\mathrm{.}36$ without the dollar sign; if the answer is $$450\mathrm{.}354$ or

$$450\mathrm{.}351,$ write $450\mathrm{.}35.)$

The two$-$year EUR$/$USD forward exchange rate should be: $

$($b$)(")$ AMB is a new firm trading forward contracts. They are buying and selling the two$-$

year EUR$/$USD forward exchange rate, and are quoting a forward exchange rate of $$1\mathrm{.}20.$

If you could trade with AMB, how would you devise an arbitrage strategy?

I would

one two$-$year EURUSD forward exchange rate

contract.

Write "buy from AMB $"$ or "sell to AMB $")$

I would borrow in the US $

with a maturity of two years.

$($Write dollar amount and round it to two decimals$)$

I would invest in the Eurozone

in a two$-$year zero$-$coupon

euro bond.

$($Write euro amount and round it to two decimals$)$

To the investment in the Eurozone, I would convert $

into euro.

$($Write dollar amount and round it to two decimals$)$

With this trading strategy, I would make $($today$)$ an arbitrage profit of $

$($Write dollar amount and round it to two decimals$)$

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