Purchase Solution

Covered interest arbitrage, foreign exchange

Not what you're looking for?

Ask Custom Question

1.Use interst rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/E, the forward rate is $1.44/E, and there are no transaction costs, the investor should invest in the U.S. security.

a.True
b. False

2.(Ma) Assume the following information:

You have $1,000,000 to invest
Current spot rate of pound = $1.60
90foward rate of pound = $1.57
3 deposit rate in U.S = 12% nominal rate
3deposit rate in U.K. = 16% nominal rate
If you use covered interest arbitrage foe a 90 day investment, what will be the amount of U.S. dollars you will have after 90 days?

3. A U.S. firm sells merchandise to a british company for E100,000 at a current exchange rate of $1.43/E. If the exchange rate changes to $1.45/E the U.S. firm will realize a _____ of ______.

Purchase this Solution

Solution Summary

Answers questions on covered interest arbitrage, investment in different currencies

Solution Preview

1.Use interst rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable british security with a return of 5%. If the spot rate is $1.43/E, the forward rate is $1.44/E, and there are no transaction costs, the investor should invest in the U.S. security.

Student Response:
a.True

Correct Response:
b. False

For interest rate parity condition to hold
Forward rate / Spot rate = (1+ US interest rate ) / (1+ British interest rate)

Spot rate= $1.43 /E
US interest rate= 4%
British interest rate= 5%

Therefore , forward rate= $1.4164 /E =1.43*(1 + 4%) / ( 1 + 5%)
Actual forward rate= $1.44 /E

Therefore E is overvalued in the forward ...

Purchase this Solution


Free BrainMass Quizzes
Learning Lean

This quiz will help you understand the basic concepts of Lean.

IPOs

This Quiz is compiled of questions that pertain to IPOs (Initial Public Offerings)

Organizational Leadership Quiz

This quiz prepares a person to do well when it comes to studying organizational leadership in their studies.

Business Processes

This quiz is intended to help business students better understand business processes, including those related to manufacturing and marketing. The questions focus on terms used to describe business processes and marketing activities.

Cost Concepts: Analyzing Costs in Managerial Accounting

This quiz gives students the opportunity to assess their knowledge of cost concepts used in managerial accounting such as opportunity costs, marginal costs, relevant costs and the benefits and relationships that derive from them.