Explanation

Given data:

• Spot USD/CHF rate: 1.3680 (1 USD = 1.3680 CHF)
• 3-month USD interest rate: 1.05% (annually compounded)
• 3-month Swiss interest rate: 0.35% (annually compounded)
• Time: 3 months = 0.25 years
• Actual futures price: USD 0.7350 (this means 1 CHF = USD 0.7350)

Step 1: Calculate theoretical forward rate Using interest rate parity: $F = S \times \frac{(1 + r_{USD})^T}{(1 + r_{CHF})^T}$

Where:

• S = Spot rate in CHF/USD = 1/1.3680 = 0.7310 (1 CHF = USD 0.7310)
• r_USD = 1.05%
• r_CHF = 0.35%
• T = 0.25 years

$F = 0.7310 \times \frac{(1.0105)^{0.25}}{(1.0035)^{0.25}}$

Calculating:

• (1.0105)^0.25 = 1.00262
• (1.0035)^0.25 = 1.00087
• F = 0.7310 × (1.00262/1.00087) = 0.7310 × 1.00175 = 0.73228

Step 2: Compare theoretical vs actual forward rates

• Theoretical forward rate: USD 0.73228 per CHF
• Actual forward rate: USD 0.7350 per CHF
• Actual > Theoretical

Step 3: Determine arbitrage strategy Since the actual forward price is higher than the theoretical price:

• CHF is overpriced in the forward market
• Strategy: Sell CHF forward, buy CHF spot

Arbitrage steps:

1. Borrow USD at 1.05%
2. Convert USD to CHF at spot rate
3. Invest CHF at 0.35%
4. Sell CHF forward at the overpriced rate

This creates a risk-free profit due to the mispricing in the forward market. The trader should borrow USD, convert to CHF at spot, invest CHF, and sell CHF forward.