1. **Problem Statement:** a) Explain five differences between forwards and futures contracts. b) Given exchange rates EUR/USD = 1.2000 (London), EUR/CAD = 1.5000 (London), USD/CAD = 1.2539 (New York), check for arbitrage opportunities and calculate profit/loss from triangular arbitrage starting with USD 1,000,000. 2. **Differences between forwards and futures contracts:** 1. Forwards are private, customizable contracts traded OTC; futures are standardized and traded on exchanges. 2. Forwards settle at contract maturity; futures are marked-to-market daily. 3. Forwards have counterparty risk; futures have clearinghouse guarantee reducing risk. 4. Forwards are less liquid; futures are highly liquid. 5. Forwards can be tailored to any amount and date; futures have fixed contract sizes and expiration dates. 3. **Arbitrage check using triangular arbitrage:** Given: $$EUR/USD = 1.2000$$ $$EUR/CAD = 1.5000$$ $$USD/CAD = 1.2539$$ Cross rate USD/CAD implied from EUR rates: $$\text{Implied } USD/CAD = \frac{EUR/CAD}{EUR/USD} = \frac{1.5000}{1.2000} = 1.25$$ Actual USD/CAD = 1.2539 Since actual USD/CAD (1.2539) > implied USD/CAD (1.25), there is a potential arbitrage opportunity. 4. **Triangular arbitrage steps starting with USD 1,000,000:** Step 1: Convert USD to EUR at EUR/USD = 1.2000 $$\text{EUR} = \frac{1,000,000}{1.2000} = 833,333.33$$ Step 2: Convert EUR to CAD at EUR/CAD = 1.5000 $$\text{CAD} = 833,333.33 \times 1.5000 = 1,250,000$$ Step 3: Convert CAD back to USD at USD/CAD = 1.2539 (means 1 USD = 1.2539 CAD, so 1 CAD = \frac{1}{1.2539} USD) $$\text{USD final} = 1,250,000 \times \frac{1}{1.2539} = 1,250,000 \times 0.7975 = 996,875$$ 5. **Profit/Loss calculation:** $$\text{Profit/Loss} = \text{USD final} - \text{USD initial} = 996,875 - 1,000,000 = -3,125$$ There is a loss of 3,125 USD, so no profitable arbitrage opportunity exists. **Final answers:** - Five differences between forwards and futures contracts as above. - Arbitrage opportunity check shows no profit. - Triangular arbitrage results in a loss of 3,125 USD starting with 1,000,000 USD.