Arizona State University FIN FIN MISC Assume that annual interest rates are 8 percent in the United States and 4 percent in Japan. The interest rates are continuously compounded. An FI…
and 4 percent in Japan. The interest rates are continuously compounded. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is USD 0.0080 per one JPY.
Suppose that, the one-year forward rate in the forward exchange market is USD 0.0081 per one JPY. Assuming that the FI can buy or sell exactly USD 1,000,000 in the forward exchange rate market, construct an arbitrage strategy whereby the FI will have zero net cash flow at time t=0 (Now), but will have some positive net cash flow in USD at time one-year from now (t=12 months). What is the amount of that positive net cash flow in USD at time t=12 months? The abbreviation USD is for US Dollar, and JPY is for Japanese Yen.
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