Question 2 (20 points) Suppose you are working for a large, international investment bank, and you observe the annual interest rate on the German corporate bonds and the British corporate bonds are 1.25% and 2.4% respectively. In addition, the current (spot) / exchange rate is 1.1900, and the euro is traded at a forward premium of 1.15% against the British pound. Note: Assume your bank does not have any funds denominated in both currencies. a) Is there is an arbitrage opportunity? Yes/No, explain. (4 points) b) Now, suppose the interest rate on the German corporate bonds increases by 35 basis points. What would you do? Explain. (5 points) c) (Continued from part b) Suppose your firm can move the markets (i.e., change the spot exchange rate, the forward exchange rate, and the corporate bond yields in both countries), what happens to these four variables after the transactions you carried in part (a)? Explain in words. (8 points) d) (Continued from part b) Fine the annualized forward premium/discount on the British pound such that your bank will be indifferent between holding the German corporate bonds and the British corporate bonds. (3 points)