The spot price at UTL in Norway is 16.50, while the forward price at UTL with a maturity of six months is 15.84. The annual interest rate in Norway is 1.6%, while the annual interest rate abroad is 10%.

a) What does it mean that a forward rate is quoted with a discount? Is that the case here? Given that the covered interest rate parity holds, how must the ratio between two countries' interest rates generally be for a forward rate to be quoted with a discount? Check whether the covered interest rate parity holds in the above case.

b) If the annual interest rate abroad had been 12%, and all other information had been as before, explain how you would have proceeded to take advantage of the present incorrect pricing. If you have NOK 3.3 million available, what amount would you have received from this trade in half a year?

Your friend wants to speculate in currency. He believes that the Norwegian krone will strengthen even more and expects that the spot rate at UTL in Norway in half a year will be 15.50. He borrows UTL 60,000 for half a year at 10% p.a., converts to NOK and places this amount in Norway for half a year at 1.6% p.a.

c) Explain why your friend wants to borrow money in the country with a high interest rate and invest money in the country with a low interest rate. What will be the result in half a year of speculation if your friend's expectation of a spot rate on UTL of 15.50 comes true ? What will be the result in half a year of speculation if the spot price on UTL is 15.84? Give a brief explanation of this result.