Suppose you saw a set of quoted prices from a U.S. bank and a French bank such that you could borrow dollars, sell the dollars in the spot foreign exchange market for euros, deposit the euros for 90 days, and make a forward contract to sell euros for
dollars and make a guaranteed profit. Would this be an arbitrage opportunity? Why or why not?
It could be an arbitrage opportunity, but it could also reflect the fact that counterparty risk differs across banks. It may be that the market knows that the default risk of the French bank is higher than other banks, which has induced the French bank to increase its promised deposit rates above rates charged by other banks with lower default risk. The perceived arbitrage opportunity would be illusory in this case.
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