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Exchange rate between australian dollar and us dollar

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Reference no: EM133120157

Assume you have observed the following information. The spot exchange rate between the Australian dollar and U.S. dollar is 1 Australian Dollar equals $0.7125 United States Dollar. Interest rates in the U.S. and Australia are 5.5 percent and 1.5 percent per annum, respectively, compounded annually. The three-month forward exchange rate is 1 Australian Dollar equals $0.7875 United States Dollar, which clearly creates an arbitrage opportunity. Explain why the observed data presents an arbitrage opportunity. Propose one possible strategy to take advantage of this situation and show your possible profit.

Reference no: EM133120157

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