10. You can buy or sell the £ spot at $1.60 to the pound. You can buy or sell the pound 1 year forward at $1.62 to the pound. If U.S. annual interest rates are 4%, what must be the one year British interest rate if interest rate parity holds?.
11. A stock has a spot price of $35. Its May options are about to expire. One of its puts is worth $5 and one of its calls is worth $5. The exercise price of the put must be ___A__ and the exercise price of the call must be ___B__. (please show work for A & B)
12. Why do mortgage lenders prefer ARMs while many borrowers prefer fixed rate mortgages, ceteris paribus?
10. Using Interest rate parity formula...
Forward rate = Spot rate * ( 1+ Interest rate of Overseas Country) / (1 + Interest rate of domestic Country)
1.62 = 1.60 *(1+4%)/(1+r)
1 + r = 1.60 *(1+4%)/1.62
1+r = 1.664/1.62
1+r = 1.02716
r = 1.02716 - 1 = 0.02716 = ...
The solution provide clear example to compute interest rate for domestic/ international currency with given scenario. In another example it will compute exercise price for both call & put option and thirdly it explains, why lender prefer ARM instead of FRM.