FX

Question

Welsher can earn arbitrage profits by:

A) buying the 2­year bond in the spot market, going long the forward contract and selling the 3­year bond in the spot market.

B) selling the 2­year bond in the spot market, going short the forward contract and buying the 3­year bond in the spot market.

C) buying the 2­year bond in the spot market, going short the forward contract and selling the 3­year bond in the spot market.

Solution

My initial idea is every time I see arbitrage to think buy low, sell high. Here I see that the forward has the higher price respectively to the bonds. Therefore I'm going to buy (cheap) 2 year bond, short the forward and sell (overpriced) 3 year bond (C)

Mistakes & Misconceptions

Basically I failed to understand the solution. Why is the forward cheap or why it should cost $98.98? If you have any idea, please share it in the group