Suppose the annual interest rate is 2.5% in U.S. and 1.5% in Japan., and that the spot exchange rate is S(¥/$) = 102 and the forward exchange rate with 12-month maturity is F12(¥/$) = 102.35 Assume you are a U.S. trader and can borrow up to $1,000,000 or ¥102,000,000. Answer the following questions.
(a) Is there an arbitrage opportunity according to the Interest Rate Parity based on the above information?
(b) Show the strategy to capture the arbitrage profit by setting up the transactions required at t=0 (i.e., today) and cash flows at t=0 and t=1 (i.e., today and 1-year from today) in a transaction table format. (Your arbitrage profit should be in U.S. dollar.)