Suppose your broker gives you the following information:

Spot exchange rate (USD/EUR) = 1:42

One-year forward exchange rate (USD/EUR) = 1:45

One-year U.S. interest rate = 6:5%

One-year foreign interest rate = 4:5%

(a) Is there any violation of the IRP?

(b) How would you take advantage of any arbitrage situation?

(c) What is your proOt?

(d) Calculate the forward spread and compare it with the interest rate dif-

ferential.

(e) Suggest a value for forward rate consistent with the IRP?