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Consider a Spanish investor with 5,000 euros to place in a bank deposit in either Spain or Great Britain. The (one-year) interest rate on bank
Consider a Spanish investor with 5,000 euros to place in a bank deposit in either Spain or Great Britain. The (one-year) interest rate on bank deposits is 3% in Britain and 4.5% in Spain. The (one-year) forward euro-pound exchange rate is 1.7 euros per pound and the spot rate is 1.6 euros per pound. Answer the following questions! a) What is the euro-denominated return (i.e. the total amount of Euros) on Spanish deposits for this investor? b) What is the (riskless) euro-denominated return on British deposits for this investor sing forward cover? c) Is there an arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market? d) If the spot rate is 1.6 euros per pound, and interest rates are as stated previously, what is the equilibrium forward rate, according to covered interest parity (CIP)? e) Suppose the forward rate takes the value given by your answer in (d). Compute the forward premium on the British pound for the Spanish investor (where exchange rates are in euros per pound). Is it positive or negative - and what does that mean? Why do investors require this premium/discount in equilibrium? Consider a Spanish investor with 5,000 euros to place in a bank deposit in either Spain or Great Britain. The (one-year) interest rate on bank deposits is 3% in Britain and 4.5% in Spain. The (one-year) forward euro-pound exchange rate is 1.7 euros per pound and the spot rate is 1.6 euros per pound. Answer the following questions! a) What is the euro-denominated return (i.e. the total amount of Euros) on Spanish deposits for this investor? b) What is the (riskless) euro-denominated return on British deposits for this investor sing forward cover? c) Is there an arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market? d) If the spot rate is 1.6 euros per pound, and interest rates are as stated previously, what is the equilibrium forward rate, according to covered interest parity (CIP)? e) Suppose the forward rate takes the value given by your answer in (d). Compute the forward premium on the British pound for the Spanish investor (where exchange rates are in euros per pound). Is it positive or negative - and what does that mean? Why do investors require this premium/discount in equilibrium
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