finance-A foreign exchange arbitrageur notices that the Japanese yen to U.S. dollar

QUESTION

A foreign exchange arbitrageur notices that the Japanese yen to U.S. dollar spot exchange rate is ¥108/$ and the three-month forward exchange rate is ¥107.30/$. The three-month $ interest rate is 5.20 percent per annum and the three-month ¥ interest rate is 1.20 percent per annum.A) is the interest rate parity holding? Which is currency is undervalued and what is amount of mispricing??B) is there an arbitrage possibility? If yes, what steps would be needed to make an arbitrage profit? Assuming that the arbitrageur is authorized to work with $1,000,000 for this purpose, how much would the arbitrage profit be in dollars?C) suppose the international parity conditions hold. Does that mean that the nominal interest rates would be equal among countries? Why or why not??

ANSWER:

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