1. Accepted characters: numbers, decimal point markers, sign indicators (-), spaces (e.g., as thousands separator, 5 000), "E" or "e" (used in scientific notation). NOTE: For scientific notation, a period MUST be used as the decimal point marker. Complex numbers should be in the form {a + bi} where "a" and "b" need to have explicitly stated values. For example: {1+1i} is valid whereas {1+i} is not. {0+9i} is valid whereas {9i} is not.

Suppose that the current spot exchange rate is 1.50/ and the one-year forward exchange rate is 1.60/. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most 1,000,000 or the equivalent pound amount, i.e., 666,667, at the current spot exchange rate.

Assume that you are a euro-based investor. Show how you can realize a guaranteed profit from covered interest arbitrage and determine the size of the arbitrage profit by answering the following questions:

a. Does IRP hold? Blank 1. Fill in the blank, read surrounding text. __________________. (Answer 1 for Yes; Answer 2 for No) b. Which currency should you borrow money from? ______________________ Blank 2. Fill in the blank, read surrounding text. (Answer 1 for ; Answer 2 for ). c. What will be your total debt in one year? ___________________ Blank 3. Fill in the blank, read surrounding text. . (Answer with just the number. No comma or symbols). d. After using the borrowed money and make an investment in another market, how much is your arbitrage profit?_____________________ Blank 4. Fill in the blank, read surrounding text. . (Answer with just the number. No comma or symbols).

Using the question from #1, how the interest rate parity may be restored as a result of the above arbitrage transactions? Answer with either rise or fall. a. Euro interest rate will Blank 1. Fill in the blank, read surrounding text. ___________. b. Pound interest rate will Blank 2. Fill in the blank, read surrounding text.____________ . c. Spot exchange rate (euros per pound) will Blank 3. Fill in the blank, read surrounding text. ____________. d. Forward rate will Blank 4. Fill in the blank, read surrounding text. _________________.