1.The forward market

a. involves contracting today for the right but not the obligation for the future purchase or sale of foreign exchange at a price agreed upon today.

b. none of the options

c. involves contracting today for the future purchase or sale of foreign exchange at a price agreed upon today.

d. involves contracting today for the future purchase or sale of foreign exchange at the spot rate that will prevail at the maturity of the contract.

2.An American currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate is i$ = 2% in the U.S. and i = 6% in the euro zone, respectively. The spot exchange rate is $1.25 = 1.00 and the one-year forward exchange rate is $1.20 = 1.00. Show how you can realize a certain dollar profit via covered interest arbitrage.

a. Borrow 800,000 at i = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to 848,000 at the forward rate of $1.20 = 1.00. Net profit will be $2,400.

b. Borrow $1,000,000 at 2%; trade $1,000,000 for 800,000 at the spot rate; invest euros at i = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = 1.00. Gross proceeds will be $1,017,600.

c. Borrow 800,000 at i = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to 850,000 at the forward rate of $1.20 = 1.00. Net profit will be 2,000.

d. Borrow $1,000,000 at 2%; trade $1,000,000 for 800,000 at the spot rate; invest euros at i = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = 1.00. Net profit will be $17,600.