Spot price for JPY is 1 USD = 100 JPY and the one year futures price is 1 USD = 110 JPY. One year interest rate on USD is 3% and interest rate on JPY is 6%.
Is there an opportunity for arbitrage profit? How much is arbitrage profit?
Yes, there is an opportunity for arbitrage profit in this scenario.
To calculate the arbitrage profit, we can follow these steps:
1. Borrow USD at the 3% interest rate for one year.
2. Convert the USD to JPY at the spot price of 1 USD = 100 JYP.
3. Invest the JPY at the 6% interest rate for one year.
4. Enter into a one-year futures contract at the price of 1 USD = 110 JPY.
At the end of the year, we would receive back the JPY from the investment with interest and settle the futures contract. If we converted the JPY back to USD at the futures price of 1 USD = 110 JPY, we would have earned more USD than we originally borrowed due to the exchange rate difference.
The arbitrage profit can be calculated as follows:
1. Borrow 1 USD at 3% for one year = 1 USD * 1.03 = 1.03 USD
2. Convert 1 USD to JPY at spot price = 1 USD * 100 JPY = 100 JPY
3. Invest 100 JPY at 6% for one year = 100 JPY * 1.06 = 106 JPY
4. Convert back 106 JPY to USD at futures price = 106 JPY / 110 JPY = 0.9636 USD
5. Arbitrage profit = 0.9636 USD - 1.03 USD = -0.0664 USD
Since the arbitrage profit is negative, it means that there is no opportunity for arbitrage profit in this scenario.