medium · FRM Part 1 Financial Markets and Products
A U.S. bank borrows 100 million JPY for one year at 1%, converts them to USD at a spot rate of 140.00, and invests them in U.S. Treasuries at 5%.
To lock in an arbitrage profit, the bank must simultaneously:
- Sell the same borrowed JPY again in the spot market exactly one year from today, unhedged.
- Increase the domestic U.S. interest rate to 6% by executing a series of separate interest rate swap contracts.
- Sell USD forward for JPY at a rate that is more depreciated than the covered interest rate parity forward rate implies.
- Buy JPY forward (sell USD forward) at a rate that allows for a repayment of the JPY loan plus interest.
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