Question 3 A. Do you agree that flexible exchange rate regime is better than fixed exchange rate regime and why? (20 marks) B. Explain the different types of risks confronting an interest rate and currency swap dealer. (25 marks) C. A currency trader sees the following information regarding the exchange rate between sterling () and US dollar ($): Spot rate: 3-month Forward rate: U.K. 3-month gilt rate: U.S. 3-month treasury bill: $ 1.8150/ $ 1.7920/ 0.25% 0.75% The currency trader could invest or borrow pounds up to 3,590,000. Sterling is the domestic currency. Note: Assume there are 360 days in a year. Required: i. According to the market, how is the value of the likely to change in 3 months? Calculate the annualised forward premium/discount. (10 marks) ii. Within the context of this problem, explain why Interest Rate Parity (IRP) should hold. Does IRP hold between the U.K. and U.S.? (15 marks) iii. If IRP does not hold, how can you make a profit? Show all the steps and determine the arbitrage profit. iv. Explain how IRP will be restored as a result of covered arbitrage activities. (15 marks) (15 marks)