Question 2 - Topic: Exchange Rate Determination

The spot bid-offer rates between Australian dollar and pounds (GBP/AUD) is quoted as 0.5144 - 0.5149. Speculator A expects the exchange rate to be 0.5130 - 0.5140, whereas Speculator B expects the exchange rate to be 0.5150 - 0.5155, in two months from the initial quotes.

a)Based on the expectations of the two speculators, which currency will appreciate and which currency will depreciate from the view of Speculator A, and Speculator B?

b)Determine the appropriate strategy between buy-low-sell-high, and short-sell positions on the AUD that each Speculator (A and B) should take given the bid-offer rates at t = 0 and their respective expected rates

t = 2 months, to realize a profit.

c)Based on your answers to part (b), calculate the profit in basis points for the different positions taken by Speculator A and B, respectively.