Question 4

a) Distinguish between transaction exposure, economic exposure, and translation exposure to currency risk. (6 marks)

b) Discuss the key differences between the operation of a currency forward market and a futures market. (7 marks)

c) Assume that the current (indirect for the UK) spot exchange rate of one pound to the dollar is $1.60/ and that the corresponding three-month forward exchange rate is $1.59/.

Also, assume that the annualised 3-month interest rate on the pound is currently 4.00% and that the corresponding interest rate on the US dollar is 2.50%.

(i) Given the information above, will you invest in the pound or borrow the pound? Explain why. (6 marks)

(ii) Calculate the amount of profit that you will realise on each pound that you borrow or

invest. (6 marks)