a. The finance manager of a U.S. pharmaceutical company has $10 million to invest for six months. The annual interest rate in the United States is 3 percent.
The annual interest rate in the United Kingdom is 1 percent. The spot rate of exchange is $1.60 per £1 and the six-month forward rate is $1.65 per £1. In which country would the finance manager want to invest the money? (You can ignore transaction costs.)
b. The spot rate between the U.S. dollar and the pound sterling is $1.70 per £1.
If the interest rate in the United States is 4 percent and 2 percent in the United Kingdom, what would you expect the one-year forward rate to be if no immediate arbitrage opportunities existed?