9. Suppose that the current spot exchange rate is 1.50/ and the one-year forward exchange rate is...

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9. Suppose that the current spot exchange rate is €1.50/£ and the one-year forward exchange rate is €1.60/£. The one-year interest rate is 5.4 percent in euros and 5.2 percent in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, that is, £666,667, at the current spot exchange rate.

a. Show how you can realize a guaranteed profit from covered interest arbitrage. Assume that you are a euro-based investor. Also determine the size of the arbitrage profit.

b. Discuss how the interest rate parity may be restored as a result of the above transactions.

c. Suppose you are a pound-based investor. Show the covered arbitrage process and determine the pound profit amount.

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ISE International Financial Management

ISBN: 9781260575316

9th International Edition

Authors: Cheol Eun, Bruce Resnick, Tuugi Chuluun

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