Question

If a currency futures contract (direct quote) is priced below the price implied by Covered Interest Parity (CIP), arbitrageurs could take advantage of the mispricing by simultaneously then:___________

A. going short in the futures contract, borrowing in the domestic currency, and going long in the foreign currency in the spot market
B. going short in the futures contract, lending in the domestic currency, and going long in the foreign currency in the spot market
C. going long in the futures contract, borrowing in the domestic currency, and going short in the foreign currency in the spot marketD. going long in the futures contract, borrowing in the foreign currency, and going long in the domestic currency, investing the proceeds at the local rate of interest

Answer 1

D. going long in the futures contract, borrowing in the foreign currency, and going long in the domestic currency, investing the proceeds at the local rate of interest

Step-by-step explanation:

Base on the scenario been described in the question, if a future contract is price below price implied by Covered Interest Parity (CIP), arbitrageurs could take advantage of the mispricing by simultaneously the going long in the futures contract, borrowing in the foreign currency, and going long in the domestic currency, investing the proceeds at the local rate of interest will go simultaneously.