Use the following information to answer question 1 and 2
Jennifer Hart worked at Goldman Sachs. She notices the following quotes:
Spot exchange rate $1.312/£
One-year forward exchange rate $1.275/£
One-year Pound interest rate 3.25% per year
One-year Dollar interest rate 2.75% per year
1. According to the Interest Rate Parity condition, what is the 1 year forward exchange rate?
a. $1.269/£ |
b. $1.281/£ |
c. $1.318/£ |
d. $1.306/£ |
2.Assuming that Jennifer Hart can work with 1,000,000 Pound or 1,312,000 Dollar; compute the arbitrage profit?
a. £57,317.65 |
b. £59,180.47 |
c. £24,817.65 |
d. $31,642.5 |
1.As per IRPT, fair forward rate = spot rate*(1+Interest rate in Dollar)/(1+Interest rate in Pound)
= 1.312(1+0.0275)/(1+0.0325)
= $1.306/Pound
i.e. d
4.Starting with pound 1,000,000
Convert into Dollar at spot rate and get 1,000,000*1.312= $ 1,312,000
Invest and get 1,312,000(1+0.0275) = $1,348,080
Convert into pound at forward rate and get 1,348,080/1.275 = Pound 1,057,317.65
Pay back Loan 1,000,000(1+0.0325) = Pound 1,032,500
Arbitrage Profit = Pound 24,817.65
i.e. c
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