Question: (a) Define uncovered interest rate parity (UIP). Derive the equations of UIP in both levels and logs. (b) Let the spot rate between the UK

(a) Define uncovered interest rate parity (UIP). Derive the equations of UIP in both levels and logs.

(b) Let the spot rate between the UK and Canada be 3.5 CAD/GBP, and the Canadian 6 month (annualised) interest rate is 6% and the 6 month (annualised) UK interest rate is 8%.

(i) What should the market quoted forward rate be to ensure there is no arbitrage opportunity?

(ii) If the actual forward rate was 4.5 CAD/GBP, demonstrate how you make an arbitrage profit with 1 CAD.

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