Answer: Borrow USD, convert to CHF at spot, invest CHF, and sell CHF forward

## 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**.

Author: LeetQuiz Editorial Team