Suppose that the forward rate of Mexican pesos per dollar is selling flat,with both the spot and forward rates trading at 15 pesos per dollar.If the relevant interest rates for a foreign exchange speculator are 3 percent on dollars and 13 percent in pesos,a potential arbitrage operation would involve
A)selling pesos in the forward market.
B)buying pesos in the forward market.
C)borrowing pesos now.
D)All of the above.

Question

Quizplus · Accepted Answer

The potential arbitrage operation would involve selling pesos in the forward market. The speculator could borrow dollars at the 3 percent interest rate, sell them for pesos at the spot rate of 15 pesos per dollar, invest the pesos at the 13 percent interest rate, and then sell the pesos back in the forward market at the same rate of 15 pesos per dollar. This would result in a profit due to the higher interest rate earned on the pesos. Buying pesos in the forward market or borrowing pesos now would not result in an arbitrage opportunity.

Suppose That the Forward Rate of Mexican Pesos Per Dollar