Question
One of UMBs high net worth U.S. clients is interested in trading British pounds. He is convinced that current market conditions make the British pounds
One of UMBs high net worth U.S. clients is interested in trading British pounds. He is convinced that current market conditions make the British pounds very attractive relative to Euro and other currencies in the region. In order to create the appropriate strategy to determine whether an arbitrage opportunity exists, Caleb lists the market data on Exhibit 6.
Exhibit 6 | |
Current $/ spot rate | 1.85 |
1-year $/ forward rate | 1.70 |
1-year U.S. Interest rates | 8% |
1-year U.K. Interest rates | 10% |
Based on Exhibit 6, Caleb tells his client the following strategy and arbitrage profit.
Strategy: Since the forward rate is lower than what the interest rate parity indicates, we would borrow British pounds, convert to dollars at the spot rate, and lend dollars.
Arbitrage profit: If we borrow 5000, we would profit $640 from the transactions.
With respect to above strategy and arbitrage profit is Caleb correct?
A. | Caleb is only correct regarding arbitrage profit | |
B. | Caleb is correct regarding strategy and arbitrage profit | |
C. | Caleb is only correct regarding strategy |
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