As a wheat futures trader, you observe the following futures prices for the purchase and sale of wheat in 3 months: $3.00 per bushel in Chicago and ¥320 per bushel in Tokyo. Delivery on the contracts is in Chicago and Tokyo, respectively
If the 3-month forward exchange rate is ¥102/$, what is the magnitude of the transaction cost necessary to make this situation not represent an unexploited profit opportunity?
The forward dollar price of wheat in Tokyo is the ratio of the futures price, ¥320 per bushel, to the forward exchange rate, ¥102/$. This ratio is ¥320 per bushel / (¥102/$) = $3.14 per bushel. Since we can buy wheat for delivery in Chicago at $3 per bushel, if transaction costs of shipping wheat from Chicago to Tokyo are smaller than $0.14 per bushel, we could make an arbitrage profit. Thus, the minimum magnitude of the transaction cost necessary to make this situation not represent an unexploited profit opportunity is $0.14 per bushel.
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