A currency trader sees the following information on his computer screen:

Spot Rate: NKr6.2280/$

3-month forward rate: NKr6.2640/$

US 3-month Treasury Bill rate: 1.4%

Norwegian 3-month Treasury Bill rate: 1.8%

The currency trader can borrow up to Nkr6.228m (or the equivalent of $1m).

(i) As implied by market prices, state how the value of the $ is expected to change over the next three months. (5 marks)

(ii) Calculate the annualised forward premium/discount at which the NKr is trading against the $. (5 marks)

(iii) Explain why theory suggests that Interest Rate Parity (IRP) should hold between countries and demonstrate (with calculations) whether or not IRP is currently holding between Norway and the US. (15 marks)

(iv) Demonstrate (with calculations) how a covered interest arbitrage profit can be achieved in this situation, stating clearly the amount of the profit that can be achieved. (15 marks)

(v) Explain precisely how IRP will be restored as a result of such covered interest arbitrage activities, stating clearly the impact on interest rates in the two countries and the spot and forward exchange rates between the two currencies. (10 marks)