• Dollar/Swiss franc spot exchange rate (in American terms) is SA = $0.5685 per Swiss Franc (SFr) — The current dollar/Swiss you invest one for ninety days domestic riskless asset

The current dollar/Swiss franc spot exchange rate is 0.5685. If you invest one dollar for ninety days in the US domestic riskless asset, you earn $1.0101, and if you invest one franc for ninety days in the Swiss riskless asset, you earn 1.0113 francs (assume continuous compounding). A broker offers you a ninety- day forward contract to buy or sell 1 million francs at the exchange rate of 0.55 dollars/franc. Are there arbitrage profi ts to be made here? If so, compute them.

SOLUTION

The data:

• Dollar/Swiss franc spot exchange rate (in American terms) is SA = $0.5685 per Swiss Franc (SFr).

• The time to maturity for the forward T = 90 days = 1/4 year.

• The price of a zero- coupon bond paying $1 after 90 days is B = 1/ (Dollar return for the US domestic riskless asset) = 1/1.0101 = $0.99.

• The price of a zero- coupon bond paying one SFr after ninety days is BE = 1 / [Dollar return for the foreign (in European terms) riskless asset] = 1/1.0113 = 0.9888 SFr.