Question 1.

Given the following information:

Current spot exchange rate: $1.80/

Six-month forward exchange rate: $1.83/

Interest rate in the U.S.: 10% per annum Interest rate in the U.K.: 7% per annum

You can borrow either $1,800,000 or 1,000,000.

a. Determine whether the Interest Rate Parity (IRP) condition holds under these circumstances

b. If IRP does not hold, outline the steps required to execute a covered interest arbitrage strategy and calculate the potential profit from this arbitrage opportunity.

Question 2.

Global Investments, an international pension fund manager, utilizes the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast future spot exchange rates. The firm collects the following financial information:

Global Investments seeks to calculate the expected spot exchange rates between the Indian Rupee (INR) and the U.S. dollar (USD).

Here is the updated financial data:

Base Price Level100

Current U.S. dollar price level 107

Current Indian Rupee price level 115

Base INR spot exchange rate $0.0135

Current INR spot exchange rate$0.0129

Expected U.S. annual inflation 6%

Expected Indian annual inflation 4%

Expected U.S. one-year interest rate 9%

Expected Indian one-year interest rate 7%

Using this information, answer the following:

a. Calculate the current INR spot rate in USD that would have been forecasted by PPP.

b. Using PPP, calculate the expected INR spot rate in USD four years from now.

c, derive the one-year forward rate using the IRPT.