Question
Currently, the spot exchange rate is $1.50/ and the three-month forward exchange rate is $1.52/. The three-month interest rate is 8.0% per annum in the
Currently, the spot exchange rate is $1.50/ and the three-month forward exchange rate is $1.52/. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or 1,000,000. 1. Determine whether the interest rate parity is currently holding. [2 MARKS] 2. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. [6 MARKS] 3. Explain how the IRP will be restored as a result of covered arbitrage activities. [2 MARKS]
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