32.6

a. The treasurer of a major U.S. firm has $5 million to invest for three months. The annual interest rate in the United States is 12 percent. The interest rate in the United Kingdom is 9 percent. The spot rate of exchange is $2/£ and the three-month forward rate is

$2.015/£. Ignoring transaction costs, in which country would the treasurer want to invest the company’s capital if he can fix the exchange rate three months hence through a forward contract?

b. The spot rate of foreign exchange between the United States and the United Kingdom at time t is $1.50/£. If the interest rate in the United States is 13 percent and 8 percent in the United Kingdom, what would you expect the one-year forward rate to be if no immediate arbitrage opportunities existed?

c. If you are an exporter who must make payments in foreign currency three months after receiving each shipment and you predict that the domestic currency will appreciate in value over this period, is there any value in hedging your currency exposure?