Suppose the currency quotation is A/B
And in the market suppose the forward is overvalued or undervalued
So to conduct the arbitrage process which currency should we borrow and which currency forward sell?
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First of all its better if think about which currency to borrow on invest based on finding out th should be interest rate and comparing with actual interest rate….Tgis is how I used to do in class.
However yet if u want to find out based on forward rate, this is how we go about…
If Actual F( A/B) is higher than should be, it means currency B is overvalued in th forward market ….we have to sell it forward…
No which currency do we sell forward in the 4th step of covered IRP…obviously th invested currency…so currency B is th invesent currency ad currency A is the borrowing currency.So arbitrage will start by borrowing currency A