Question

global investor gathered information on currencies and interest rates in France and the United Kingdom as...

global investor gathered information on currencies and interest rates in France and the United Kingdom as shown below:

Discrete risk-free rate (France) 6.00%
Discrete risk-free rate (United Kingdom) 4.00%
Spot exchange rate per British pound €1.27
Market price of a 90-day futures contract on GBP (£) €1.28

As part of a possible arbitrage strategy:

Indicate whether the futures contract is overpriced or underpriced:

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Answer #1
Per the IRPT, the forward price should be:
S1 = S0*(1+rEuro)/(1+rGBP), where, S1 = Current
spot Euro/GBP, S1 = The expected future spot,
rEuro = risk free rate in Euro and rGBP = risk free
rate in GBP.
Substituting values, the S1 = 1.27*1.015/1.01 = €            1.2763
The futures contract is overpriced as, its value is
more than the theoretical value given by the IRPT.
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