Will an arbitrageur facing the following prices be able to make money? Borrowing Lending Bid Ask$5% 4.5% Spot$1.00 = €1.00 $1.01 = €1.00€6% 5.5% Forward$0.99 = €1.00 $1.00 = €1.00
A. Yes, borrow €1,000 at 6 percent; trade for $ at the bid spot rate $1.00 = €1.00; invest $1,000 at 4.5 percent; hedge this with a forward contract on €1,045 at $1.00 = €1.00.
B. No; the transactions costs are too high.
C. Yes, borrow $1,000 at 5 percent; trade for € at the ask spot rate $1.01 = €1.00; Invest €990.10 at 5.5 percent; hedge this with a forward contract on €1,044.55 at $0.99 = €1.00; receive $1.034.11.
D. none of the options
Answer: B
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