Answer: Borrow USD, buy CHF spot, and sell CHF forward

## Explanation To determine the correct arbitrage strategy, we first need to calculate the theoretical forward rate using the interest rate parity formula: **Forward Rate = Spot Rate × (1 + r_foreign) / (1 + r_domestic)** Where: - Spot Rate = 1.3680 CHF/USD (1 USD = 1.3680 CHF) - r_USD = 1.05% (domestic currency) - r_CHF = 0.35% (foreign currency) - Time = 3 months = 0.25 years **Calculation:** Forward Rate = 1.3680 × (1 + 0.0035×0.25) / (1 + 0.0105×0.25) Forward Rate = 1.3680 × (1.000875) / (1.002625) Forward Rate = 1.3680 × 0.99825 Forward Rate = 1.3656 CHF/USD This means the theoretical forward rate should be 1.3656 CHF/USD, or equivalently: 1 CHF = 1/1.3656 = 0.7323 USD **Given market forward price:** 0.7350 USD/CHF **Analysis:** - Theoretical forward: 0.7323 USD/CHF - Market forward: 0.7350 USD/CHF The CHF is **overpriced** in the forward market (0.7350 > 0.7323). **Arbitrage Strategy:** To exploit this, we should: 1. **Sell CHF forward** (since it's overpriced) 2. **Buy CHF spot** (to cover the forward sale) 3. **Borrow USD** (to finance the spot purchase) This corresponds to **Option A: Borrow USD, buy CHF spot, and sell CHF forward**. **Arbitrage Profit:** The trader can lock in a risk-free profit by selling CHF at the overpriced forward rate of 0.7350 USD/CHF while simultaneously buying CHF at the fair theoretical price of 0.7323 USD/CHF.

Author: LeetQuiz .