1. (10points) Suppose you are a U.S.-based investor with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.60 = 1.00 and the dollar-pound exchange rate is quoted at $2.00 = 1.00. If a bank quotes you a cross rate of 1.00 = 1.20. Is there any arbitrage opportunities? What transactions will you carry out? How much money can you make?

2. (5points) As of today, the spot exchange rate is 1.00 = $1.60 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?

3. (15 points) Suppose that the annual interest rate is 5% in the U.S. and 8% in the U.K. The spot exchange rate is $1.80/. Assume that the arbitrager can borrow up to $1,000,000 or 555,556. If the one-year forward rate is $1.72/.

1. What is the no arbitrage one-year forward rate implied by Interest Rate Parity (IRP)?

2. What transactions will the arbitrager carry out? How much profit can the arbitrager make in terms of dollar?

3. Discuss how IRP will be restored in this case.

4. (15 points)From the perspective of the writer of a put option written on 62,500. If the exercise price is $1.55/, and the option premium is $0.03/.

1. At what exchange rate do you start to lose money?

2. What is your maximum profit?

3. What is your maximum loss?

4. If the spot exchange rate is $1.54/ calculate the intrinsic value and the time value of the put option.

5. Draw the profit graph for the writer of this put option

5. (15 points) Medstat enters into a 3-year pay pounds receive US dollar cross-currency swap. Medstat will pay 1.2% fixed pound interest, and receive 1.4% fixed dollar interest. The principle is $10,000,000 and the current exchange rate is $1.5/.
   1. Calculate the cash inflows and out flows for Medstat for the next three years.

2. Calculate the gain or loss if Medstat wants to unwind (terminate) the cross-currency swap after two years. Assuming the 1-year pound rate is 1.5% and dollar rate is 1.2%, and the exchange rate is $1.2/ then.