1. Consider a US exporter that sells machines in the UK in GBP. The exporter believes that for each $0.10 decrease in the USD/GBP exchange rate it will make a loss of $250,000. How many USD/GBP futures does the exporter need to go long or short to hedge the exchange rate risk if the size of one GBP futures is 62500 pounds? (10 marks)
2. Consider the following information. The $/ exchange is currently 1.25. Assume the one-year forward rate is F0=1.2 $/, one year US interest rates are rUS =0.5%, one year UK interest rates are 1.5%. What arbitrage strategy is possible? Calculate the arbitrage profits in US dollars.