Forward Market Arbitrage-Forward Premium discount and Interest
Subject: Business / Finance
Question
Forward Market Arbitrage
Forward Premium (discount and Interest Rates Differential
Yen Pound S/peseta
1-Month Forward 5.4(5.7) -1.9(-1.9) 1.2(1.2)
3-Months Froward 4.8(5.3) -1.9(-1.8) 1.2(1.2)
1-year Forward 4.5(5) -1.8(-1.6) 1.6(1.5)
The first number is U.S. interest rate -Foreign interest rate. For example for 1-year forward Yen of 4.5%, it is the U.S 1-year rate less Japanese 1-year rate. The number in the parenthesis is 5 for 1-year forward yen. This number is the forward premium in yen as it is positive.
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Question: Suppose you can borrow $10 million or its yen equivalent, what actions would you take in 1-year yen forward market in order to make arbitrage profit? How much arbitrage profit you are likely to make?
