Question 1:
What makes a foreign exchange market different than a domestic market? Using examples, describe how forward markets and spot markets operate in the foreign exchange market.
Question 2:
Imagine visiting overseas, where you win the local lottery and can buy any foreign car you wish and will pay full retail price using the local currency, payable in three months.
You have determined that you have enough cash at your bank in New York City, which pays 0.35 percent interest per month, compounding monthly, to pay for the car. There are two ways to pay for your car:
Keep the funds at your bank in the United States and buy a forward contract to pay for the car.
Buy a certain currency amount spot today and invest the amount in the foreign bank for three months so that the maturity value becomes equal to the price of the car
Analyze the two alternatives presented and make a recommendation on purchasing the car. How could this purchase opportunity be considered arbitrage?
Be sure to provide calculations for your recommendation showing the best alternative. What are the advantages of the alternative that you have selected?