You are a foreign exchange trader specialized in the US dollar (USD) and Canadian dollar (CAD) market (CAD/USD). One morning, you find the following two CAD/USD quotes: Quote A: 1.03-1.035 and Quote B: 1.038 - 1.042 Quotes are read as: (bid price (buy price) - ask price (sell price)
(i) Can you make money from these quotes, how and why? What will happen to the forex market rate CAD/USD if you continue trading with your strategy?
(ii) Another morning, you notice that the one-year US dollar interest rate is 4%, while the one-year interest rate on CAD deposits is 2.7%. Today's CAD/USD rate is $1.7. What spot rate do you expect for the CAD/USD in one year?
(iii) You log onto your electronic brokerage account and find that the current quote for the 360-day forward rate on CAD/USD is 1.0459. Is there an arbitrage opportunity? If so, describe how you would take profit from it and how much you would get if you invested $1. What do you anticipate if all of your fellow traders start doing the same?