Suppose the spot price of GBP is US$1.1248, the continuously compounded risk free rate is 5% p.a in the US. Suppose the 1-year forward rate is $1.1344.

(a) What is the interest rate prevailing in the UK?

(b) What is the 2-year forward rate?

(c) Suppose the 2-year forward exchange rate is $1.1392. What arbitrage opportunities does this create? If so, please explain carefully how you would trade to take advantage of the arbitrage opportunities. (Whichever currency you borrow, please use 1000 units of that currency.)

(d) Repeat question (c) above if the 2-year forward exchange rate is $1.1557

Answer rating: 100% (QA)

aThe interest rate prevailing in the UK is 475 This can be calculated by using the following formula rUK rUS F SS 100 where rUK interest rate prevaili... View the full answer