3. The spot exchange rate and the three-month forward exchange rate of the British pound vis--vis the US dollar are quoted in New York as follows: So= $1.3643/ with a spread 640-646 F0.90 = $1.3573/ with a spread 570 - 576 The interest rate at which the trader can borrow or lend in the US is 2.50% per annum, and it is expected to remain unchanged in the next three months; The interest rate at which the trader can borrow or lend in the UK is 3.25% per annum now, and it is expected to remain unchanged in the next three months. Required: (a) Calculate and compare the forward premium and interest rate differential to verify that arbitrage opportunities may or may not exist in this case. (5 marks) (b) What should be the US interest rate if covered interest rate parity (CIRP) holds while other figures remain unchanged? (5 marks) (c) Set up procedures to exploit the arbitrage opportunities. Work out how big the arbitrage profit is, taking into account the transaction costs in the foreign exchange market as indicated by the bid-ask spread in the quotations. (15 marks) 3. The spot exchange rate and the three-month forward exchange rate of the British pound vis--vis the US dollar are quoted in New York as follows: So= $1.3643/ with a spread 640-646 F0.90 = $1.3573/ with a spread 570 - 576 The interest rate at which the trader can borrow or lend in the US is 2.50% per annum, and it is expected to remain unchanged in the next three months; The interest rate at which the trader can borrow or lend in the UK is 3.25% per annum now, and it is expected to remain unchanged in the next three months. Required: (a) Calculate and compare the forward premium and interest rate differential to verify that arbitrage opportunities may or may not exist in this case. (5 marks) (b) What should be the US interest rate if covered interest rate parity (CIRP) holds while other figures remain unchanged? (5 marks) (c) Set up procedures to exploit the arbitrage opportunities. Work out how big the arbitrage profit is, taking into account the transaction costs in the foreign exchange market as indicated by the bid-ask spread in the quotations. (15 marks)