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You are an investor in the US. The current spot exchange rate is 1.500 USD/GBP. The annual risk-free interest rate is 5.0% in the U.S.
You are an investor in the US. The current spot exchange rate is 1.500 USD/GBP. The annual risk-free interest rate is 5.0% in the U.S. and 4.0% in the UK.
a) What is the no arbitrage one year forward exchange rate?
b) Suppose that you observe that one year forward exchange rate is 1.600 USD/GBP. Does Interest Rate Parity hold?
c) Assume that you can borrow $1,500,000 or 1,000,000.Make an arbitrage strategy, determine the arbitrage profit (if any, otherwise type "0") and report it in USD.
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