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Q3) (10 Points) The spot currency exchange rate between the US and the UK is USD/ GBP 1.30. One year forward rates for the next
Q3) (10 Points) The spot currency exchange rate between the US and the UK is USD/ GBP 1.30. One year forward rates for the next three years are: USD GBP Year 1 2.00% 2.50% Year 2 5.00% 3.50% Year 3 4.00% 3.20% 2 year forwards in the currency market are being offered at 1.32 and 3 year forwards at 1.31. Use annual continuous time discounting. Also assume that any arbitrage gains can be converted to the investor's currency at the contracted forward rate. a) Is there an arbitrage opportunity for a US investor (Investor A) who is willing to invest $100M to take advantage of any mispricing at the 3 year point? Show the trade and resulting cash flows. b) Compute the profit opportunity for another US investor (Investor B) who is also investing $100M but is looking to profit from any mispricing in year 2
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