Question

Use the following information to answer question 1 and 2 Jennifer Hart worked at Goldman Sachs....

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
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Homework Answers

Answer #1

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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