Question
I am having some difficulties is grasping this subject aboput currency forwards arbitrage. It is obvious that you sell overpriced or buy underpriced assets. In this case FP arbitrage free USD/YEN = .00812*(1.045/1.02)^(90/365)= .00817
dealer quoted forward .00813 which is < Forward price 00.817 so we buy because is cheap
buy underpriced asset based currency YEN Can someone explain me please the steps in detail?
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R
say you borrow a 1,000 yen
after 3 months you would have to pay back 1,000*1.02^1/4 = 1,004.9629 yen
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convert the 1,000 yen to at spot -\> you get 8.12 (1000 * .00812 $/yen)
after 3 months this becomes 8.12 * 1.045 ^ 1/4 = $8.209847723
convert to yen at the forward rate of 0.00813 -> 1,009.821 yen
pay the 1,004.9629 yen and be left with 4.8585 yen profit.
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since the actual forward rate of 0.00817 yen/ is higher than the 0.00813 yen/ rate available - you borrow yen in the market (buy the cheaper currency)
I wrote an article that may be of some help here: http://financialexamhelp123.com/covered-interest-rate-parity-irp-pricing-currency-forwards/
thanks for your input
it confuses me with these notations USD/YEN YEN/USD
It’s especially confusing if you work with currencies regularly, as CFA Institute’s notation is the reverse of the common notation in the industry.
Sorry.
Cool