Arizona State University FIN FIN MISC In the interest rate market, you are given annual interest rates of…

Arizona State University FIN FIN MISC In the interest rate market, you are given annual interest rates of…

In the interest rate market, you are given annual interest rates of 4 percent in the United States and 7 percent in Japan. The interest rates are continuously compounded. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. In the foreign currency market, at time t=0 (Now), the spot rate is JPY 125 per one USD. And the one-year forward exchange rate is USD 0.0077 per one JPY.

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If there is an arbitrage opportunity, then what should be the FI’s arbitrage strategy at time t=0 (now)?

S1) In the US interest rate (bond) market, FI will _______ (Buy or Sell) U.S Dollar for one year

S2) In the Japanese interest rate (bond) market, FI will ______ (Buy or Sell) Japanese yen for one year

S3) In the currency market, FI will ______ (Buy or Sell) US Dollar at the spot exchange rate.

S4) In the currency market,, FI will enter into a forward exchange rate agreement whereby it will (Buy or Sell) Japanese yen one year from now

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