<p>You can have a look at the wikipedia article about <a href="https://en.wikipedia.org/wiki/Interest_rate_parity#Covered_interest_rate_parity" rel="nofollow noreferrer">covered interest rate parity</a>.</p>
<p><a href="https://i.sstatic.net/w8Aze.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/w8Aze.png" alt="enter image description here" /></a></p>
<p>Any deviation is an arbirtage opportunity. In your case, <span class="math-container">$${{S_{t}}}\frac  {(1+i_{\ ¥})}{(1+i_{\\\$})} = F_{t+k}$$</span></p>
<p>If you think of USDJPY now (how many JPY per USD), if JPY interest rate is 2% and USD 5% you get (for a year), the value of</p>
<p><span class="math-container">$${100}*\frac  {(1+0.02)}{(1+0.05)} = 97.1428571428571$$</span> which is the fair forward value. The higher interest rate country is depreciating (US). Here is your arbitrage.</p>
<p>In reality though, the two bonds will not have the same expiry date, coupon payments will fall on different dates and you only have one forward contract. So there is no real riskless arbitrage here.</p>

CC BY-SA 4.0
2023-01-04T23:56:49.690Z
2023-01-04T23:56:49.690Z
AKdemy
<p>If you have a Japanese bond with a return of 2%, and an American bond paying 5%, but <strong>both current and forward exchange rates are 100 yen to 1 usd</strong>, how would one take advantage of this opportunity to make riskless returns?</p>
<p>As far as I see, you could short the American bond, but how would you pay it back? What would one do in practice?</p>

<interest-rate><foreign-exchange><trading><arbitrage>
How would one arbitrage a mispricing in interest rates and forex rates?
user43188
# How would one arbitrage a mispricing in interest rates and forex rates?

(Asked by: username_0 on 2023-01-04)

If you have a Japanese bond with a return of 2%, and an American bond paying 5%, but **both current and forward exchange rates are 100 yen to 1 usd**, how would one take advantage of this opportunity to make riskless returns?

As far as I see, you could short the American bond, but how would you pay it back? What would one do in practice?

**Tags:** interest-rate, foreign-exchange, trading, arbitrage

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## 1 answers

### Answer by username_1 on 2023-01-04. Score: 1

You can have a look at the wikipedia article about [covered interest rate parity](https://en.wikipedia.org/wiki/Interest_rate_parity#Covered_interest_rate_parity).

[![enter image description here](https://i.sstatic.net/w8Aze.png)](https://i.sstatic.net/w8Aze.png)

Any deviation is an arbirtage opportunity. In your case, $${{S\_{t}}}\frac {(1+i\_{\ ¥})}{(1+i\_{\\\$})} = F\_{t+k}$$

If you think of USDJPY now (how many JPY per USD), if JPY interest rate is 2% and USD 5% you get (for a year), the value of

$${100}\*\frac {(1+0.02)}{(1+0.05)} = 97.1428571428571$$ which is the fair forward value. The higher interest rate country is depreciating (US). Here is your arbitrage.

In reality though, the two bonds will not have the same expiry date, coupon payments will fall on different dates and you only have one forward contract. So there is no real riskless arbitrage here.


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