Question $5$

An investor enters into a $3-$month forward contract on Canadian dollar with a notional amount of $1$ million Canadian dollars, and the forward exchange rate is USD $\frac{0\mathrm{.}7429}{?}$ CAD.

A$.$ If the investor expects the Canadian dollar to appreciate over the following three months, what position will he take $($long or short$)$ in the forward contract?

B$.$ If the investor expects the Canadian dollar to depreciate over the following three months, what position will he take $($long or short$)$ in the forward contract?

C$.$ If the investor takes a short position, and the spot exchange rate turns out to be USD $\frac{0\mathrm{.}7500}{C}AD$ in three months, how much is the investor's dollar profit $($or loss$)?$ What would be the answer if the investor takes a long position instead?

Question $6$: Ch $6$

Suppose an investor received the following quotes:

Spot exchange rate: USD $0\mathrm{.}83/$Euro;

$6-$month forward exchange rate: USD $\frac{0\mathrm{.}87}{?}$ Euro.

The $6-$month interest rate is $4\%$ per annum in the U$.$S$.$ and $5\%$ per annum offered by a European bank. Assume that the investor can borrow as much as US $$1,000,000.$

A$.$ Determine whether the interest rate parity $($IRP$)$ is holding.

B$.$ If the IRP is not holding, how would the investor carry out a covered interest arbitrage? Show all the steps and determine the arbitrage profit.

C$.$ Once the arbitrage is implemented, how would the interest rates and exchange rates change to restore the IRP? They would go up or down? Briefly discuss.