1.Consider a Dutch investor with 1,000 euros to place in a bank deposit in either the Netherlands or Great Britain. The (one-year) interest rate on bank deposits is 2% in Britain and 4.04% in the Netherlands. The (one-year) forward euro-pound exchange rate is 1.575 euros per pound and the spot rate is 1.5 euros per pound. Answer the following questions, using theexactequations for UIP and CIP as necessary.

a.What is the euro-denominated return on Dutch deposits for this investor?

b.What is the (riskless) euro-denominated return on British deposits for this investor using forward to cover exchange rate risk?

c.Is there an arbitrage opportunity? Explain why or why not. Is this an equilibrium in the forward exchange rate market?

d.If the spot rate is 1.5 euros per pound, and interest rates are as stated previously, what should be the equilibrium forward rate, according to CIP?

e.Suppose the forward rate takes the value given by your answer to (d). Calculate the forward premium on the British pound for the Dutch investor (where exchange rates are in euros per pound).

f.If both CIP and UIP holds, and the forward rate takes the value given by your answer to (d), what is the expected depreciation of the euro against the pound over one year?

g.Based on your answer to (f), what is the expected euro-pound exchange rate one year ahead?

2.Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to $.50. The following annual interest rates apply:

Currency: Dollars

Lending Rate: 7.10%

Borrowing Rate: 7.50%

Currency: New Zealand dollar (NZ$)

Lending Rate: 6.80%

Borrowing Rate: 7.25%

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank's forecast is correct, what will its dollar profit be from speculation over the five-day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)?

3.Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Use the value-at-risk (VAR) method based on a 95% confidence level. What is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0.5%?

4.Baylor Bank, a British investment bank believes the New Zealand dollar will appreciate over the next 10 days from $.48 to $.50. It also believes that the British pound will stay constant at the value of $1.3 over the next 10 days. The following annual interest rates apply:

Currency: Dollars

Lending Rate: 7.0%

Borrowing Rate: 7.40%

Currency:New Zealand dollar (NZ$)

Lending Rate:6.70%

Borrowing Rate:7.20%

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. It will also invest with 1 million of its fund. If Baylor Bank's forecast is correct, what will its profit (measured in British pound) be from speculation over the 10-day period?