Assume the spot exchange rate of the New Zealand dollar is USD0.6215 and that three-month...
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Assume the spot exchange rate of the New Zealand dollar is USD0.6215 and that three-month continuously compounded risk-free rates are 5.0% p.a. and 5.5% p.a. in the US and New Zealand, respectively.
(a) What is the theoretical price of a three-month forward contract on the New Zealand dollar? Round your answer to four decimal places.
(b) Assume that the actual three-month forward rate is USD0.6185. Show in detail how an arbitrageur initially borrowing either NZD 1 million or USD 1 million could take advantage of this mispricing to earn an arbitrage profit. Make sure that you clearly identify the profit accruing to the arbitrageur at the expiration of the arbitrage strategy.
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