Finance Question

Question ci Mandy, an U.S. investor, would like to conduct carry trade in order to capitalize on the higher interest rate in UK by using her own US$1,000,000 saving. The following information is obtained by Mandy: US$1.25 Spot rate of pounds Annual interest rate of U.S. dollars Annual interest rate of pounds 5% 8% Required: (a) Calculate the annual yield of the investment if the future spot rate of pounds will be depreciated by 2% after 1 year. (6 marks) (b) Calculate the one-year forward rate of pounds if interest rate parity is held. (3 marks) (c) Referring to the above case, explain the following without any calculations: (i) how forward contract is used to hedge exchange rate risk. (3 marks) (ii) how borrowing affects the return