Q. Investing interest rates in the U.K. are 4.25% p.a. and in Australia they are currently at 3.6% p.a. The GBP/AUD spot rate is 1.8838

(a) Assume no transaction costs. Calculate the theoretical three-year forward rate of the GBP implied by Interest Rate Parity.

(b) Now assume the actual three-year forward rate is GBP/AUD 1.7933. What, if any, is the percentage return from engaging in Covered Interest Arbitrage? Assume a transaction cost of 0.3% in the spot and the forward market. Also assume that borrowing rates are 0.8% higher than the investing rates in both countries.

answer will be either (choose the appropriate one):

A. Arbitrage: Calculate the result as a percentage of your initial borrowing, accurate to 4 decimal

places, making sure to include any opportunity costs in your calculations).

B. No arbitrage: If there is no arbitrage available then show how you are unable to make money

through a covered interest arbitrage process.

please Show workings and no words limit