Question 3 A Swansea based fund has raised 10 m to invest in Frankfurt Stock Exchange. The current spot rate of to is 1.11. The fund plans to sell the portfolio in one year and then exchange all to . The fund expects the interest rates in the UK and Germany would be 0.5% and 0.01% respectively in the next year. The current forward rate of to (in one year) in the market is 1.05. (a) What is the foreign exchange risk for the fund's investment plan? [3 marks] (b) Briefly explain what factors would decide the exchange rate between and . [10 marks] (c) Calculate the One-year future rate of to if interest rate parity holds. Explain the rationality of such a future rate. [4 marks] (d) If your estimation of future rate in question (C) is correct, is it necessary to use current forward contract (1 = 1.05) to hedge the foreign exchange risk? Explain your answer. [3 marks] (e) Explain how the fund could use the Money Market to hedge the foreign exchange risk. [5 marks] [Total 25 marks] Question 3 A Swansea based fund has raised 10 m to invest in Frankfurt Stock Exchange. The current spot rate of to is 1.11. The fund plans to sell the portfolio in one year and then exchange all to . The fund expects the interest rates in the UK and Germany would be 0.5% and 0.01% respectively in the next year. The current forward rate of to (in one year) in the market is 1.05. (a) What is the foreign exchange risk for the fund's investment plan? [3 marks] (b) Briefly explain what factors would decide the exchange rate between and . [10 marks] (c) Calculate the One-year future rate of to if interest rate parity holds. Explain the rationality of such a future rate. [4 marks] (d) If your estimation of future rate in question (C) is correct, is it necessary to use current forward contract (1 = 1.05) to hedge the foreign exchange risk? Explain your answer. [3 marks] (e) Explain how the fund could use the Money Market to hedge the foreign exchange risk. [5 marks] [Total 25 marks]