The Interest Rate Parity is one of the key international parity relationships that have profound implications for international financial management in the sense that it can be used in how foreign exchange rates are determined, and to forecast foreign exchange rates. The current spot exchange rate is $1.50/ and the three-month forward exchange rate is $1.52/. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or 1,000,000.

Required (Highly encouraged to use calculations):

i. From the above information, determine whether the interest rate parity is currently holding. (3 Marks)

ii. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. (7 Marks)

iii. Explain how the IRP will be restored as a result of covered arbitrage activities. (5 Marks)

iv. Explain the conditions under which the forward exchange rate will be an unbiased predictor of the future spot exchange rate. (5 Marks)

v. Explain what Interest rate parity (IRP) entail and how it can be used to provide the linkage between interest rates in two different countries. (5 Marks)