Question

b) Suppose that the current spot exchange is: 1 BP (British pound) = $1.21. Use the following interest rates.

The interest rate is 8% in the US market (home market).

The interest rate is 3% in the UK market (foreign market).

i) Find the forward exchange rate when the IRP holds.

ii) Assume that the IRP holds (this means you use the IRP forward exchange rate found above). When you invest $10,000 in the UK market and at the same time, enter a currency forward contract to sell BP in a year, show that the return from your foreign investment is equal to the return that can be achieved from the US market (home market).

iii) If the forward exchange rate is 1 euro = $1.23, from what market will you have more investment return (%)? Show your work.

Answer 1

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