What conditions could an arbitrage opportunity be possible

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Question

There are two countries whose currency are freely traded, Country Alpha and Country Beta. The current spot exchange rate is 1A = 1B, where A and B are also the currency symbols of Alpha and Beta, respectively. The 90-day forward rate is 1.5A = B. More so, assume that a risk-free (1-year time-deposit) investment exist in both countries and that a banker's year (i.e., 360-days) is used for any calculations. This means if you lock your money away for 1- year there will be no loss to its principal and you will gain an interest rate of iA or iB, respectively.

Under what conditions could an arbitrage opportunity be possible? Clearly state and justify any assumptions you make. Give an intuitive interpretation of your result.

Reference no: EM133496024

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