The treasurer of IBM has an extra cash reserve of $100,000,000 to invest for six months. The sixmonth

interest rate is 8% per annum for $ deposit and 7% per annum for deposit of the same

credit risk. The spot exchange rate is 1.01/$. The six-month forward exchange rate is 0.99/$. (1)

How should the extra cash reserve be invested? Explain. (2) Describe all transactions the treasurer

needs to take.

The spot exchange rate is $1.50/. The three-month forward exchange rate is $1.52/. The 3-month

interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Investors can borrow

either $1,500,000 or the equivalent amount at the current spot rate.

(1) Is there any covered interest arbitrage (CIA) opportunity for a dollar-based investor? If yes, show

his CIA process and calculate his arbitrage profit.

(2) Is there any covered interest arbitrage (CIA) opportunity for a pound-based investor? If yes,

demonstrate his CIA process and calculate his arbitrage profit amount.

(3) Based on the given information, discuss how CIA activities help restore the market equilibrium

described by interest rate parity (IRP).

The current price level in the U.S. is $14,000 per consumption bundle, and 10,000 per

consumption bundle in the U.K.. The current exchange rate is $1.65/. You are trying to decide

between two job offers. One consulting firm offers you $150,000 per year to work in its New York

office. A second consulting firm wants you to work in its London office with an offer of 100,000

per year. Assume you are indifferent between working in the two cities if the purchasing power of

your salary is the same. Which offer should you take? Explain.

The current price level in the U.S. is $14,000 per consumption bundle, and 10,000 per

consumption bundle in the U.K.. The current exchange rate is $1.65/. The annual inflation rate is

expected to be 2% in the U.S. and 5% in the U.K. If is going to weaken against dollar by 3.6% in

the next year, discuss how is the absolute purchasing power and relative purchasing power of dollar

going to change. Which country will become more competitive in the world market? Explain.

Due to the integrated capital markets, investors in the U.S. and U.K. require the same real interest

rate (2.5% per year) on their lending. There is a consensus in capital markets that the annual

inflation rate is likely to be 3.5% in the U.S. and 1.5% in the U.K. for the next three years. The

current spot rate is $1.50/.

(1) Using PPP, calculate the expected future spot rate one year from now.

(2) Compute the nominal interest rate per annum in the U.S. and in U.K., assuming that the Fisher

effect holds.

(3) Using IFE, calculate the expected future spot rate three years from now.