Question: A foreign exchange trader based in the U.S. notices the following information. 1-year U.S. interest rate: 8% 1-year U.K. interest rate: 10% 1 year forward

A foreign exchange trader based in the U.S. notices the following information. 1-year U.S. interest rate: 8% 1-year U.K. interest rate: 10% 1 year forward exchange rate: 1.70 USD/GBP Spot exchange rate: 1.85 USD/GBP Assume that the foreign exchange trader can borrow or lend USD at the interest rate in the US and can borrow or lend GBP at the interest rate in the UK, and that the foreign exchange trader can buy or sell forward contracts. a) Explain why the data above are not consistent with the interest rate parity. b) If the foreign exchange trader is authorized to work with GBP 5000 and its equivalent amount in USD, what steps can he take to make an arbitrage profit? How much will be the arbitrage profit in USD?

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