Final answer:
The student's question revolves around identifying an arbitrage opportunity based on interest rates and currency exchange rates. The key concept here is the interest rate parity condition that helps in calculating the correct forward rate to preclude arbitrage. Determining the differences in rates can expose arbitrage opportunities, which can then be exploited using covered interest arbitrage strategy.
Step-by-step explanation:
The student is asking whether there is an arbitrage opportunity given the spot and forward exchange rates for the Norwegian krone and the prevailing interest rates in the United States and Norway. To determine this, we take into account the interest rate parity condition, which states that the difference in interest rates between two countries should equal the difference between the forward and spot exchange rates, to prevent arbitrage.
To explore whether an arbitrage opportunity exists, one would calculate the expected forward rate using the interest rates provided. If the actual forward rate is different from this calculated rate, an arbitrage opportunity exists. To exploit this opportunity, an investor could leverage the differences in interest rates and exchange rates through a covered interest arbitrage strategy. Lastly, the correct six-month forward rate to prevent arbitrage should be calculated considering the interest rate differential.
Based on the information given, the no-arbitrage forward rate can be computed as follows: (Spot Rate) × (1 + interest rate of foreign currency) / (1 + interest rate of domestic currency). The calculated no-arbitrage forward rate would indicate the rate at which no profit could be made from arbitrage.