Question 1:

Interest rates in India are 5.25% p.a. and in Brazil they are currently at 2.5% p.a. The BRL/INR spot rate is 13.37.

(a) Calculate the theoretical three-year forward rate of the BRL implied by Interest Rate Parity.

(b) Now assume the actual two-year forward rate is BRL/INR 15.20. 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. (Calculate the result as a percentage of your initial borrowing, accurate to 4 decimal places, making sure to include any opportunity cost in your calculations)

Question 2:An Australian exporting company will receive 4m USD in 6 months' time from sales. The current spot rate is: AUD / USD 0.7066 / 0.7073. Australian interest rates are currently at 1.5% p.a. and U.S. interest rates are at 0.5% p.a. The net interest rate spread in both countries is 3.5% (read this as the borrowing rates are 3.5% higher than the given investment rates above). Design a money market hedge which will remove the FX risk faced by the company, yet not altering the timing of the payment. Clearly show the AUD cash flow in the future.