Assume the following information:

You have $1,000,000 or the equivalent to invest

Current spot rate of pound = $1.30

90-day forward rate of pound = $1.27

3-month nominal interest rate in U.S. = 5%

3-month nominal interest rate in Great Britain = 7%

3-month expected inflation rate in U.S. = 2%

3-month expected inflation rate in Great Britain = 5%

1). Does interest rate parity hold in this case? ____Yes or No____ Check if covered interest arbitrage is feasible.

2). If yes, who will benefit from it, U.S. investors or British investors? Calculate the riskless profit in dollars or pounds. Show all steps.

3). How must the premium/discount change to maintain interest rate parity?

Forward _____________ (premium/discount) will _________ (increase/decrease) to __________%.

Spot rate of British Pound will __________ (increase/decrease) due to __________ (increasing/decreasing) _________ (supply/demand) of ________ (British Pound/dollar)

Forward rate of British Pound will __________ (increase/decrease) due to __________ (increasing/decreasing) _________ (supply/demand) of __________ (British Pound/dollar).

4). According to purchasing power parity, what is the expected spot rate of the pound in three months?

5). According to international Fisher effect, what is the expected spot rate in three months?