--%>
Assignment Help - homework help

Determining interest rate parity

Presently, spot exchange rate is $1.50/£ and three-month forward exchange rate is $1.52/£. Three-month interest rate is 8.0% per annum within the U.S. and 5.8% per annum within the U.K. Suppose that you can borrow as much as $1,500,000 or £1,000,000. 

a) Determine if the interest rate parity is presently holding.

b) In case IRP is not holding, how could you carry out the covered interest arbitrage? Display all steps and also compute the arbitrage profit.

c) Describe how IRP will be restored due to covered arbitrage activities.

E

Expert

Verified

Firstly, let summarize the given data:

   S = $1.5/£; F = $1.52/£;  I$ = 2.0%;  I£ = 1.45%

   Credit = $1,500,000 or £1,000,000.

a. (1+I$) = 1.02

    (1+I£)(F/S) = (1.0145)(1.52/1.50) = 1.0280

Hence, IRP is not holding exactly.

b. a) Borrow $1,500,000; repayment will be $1,530,000. 

    c) Buy £1,000,000 spot using $1,500,000.

    d) Invest £1,000,000 at pound interest rate of 1.45%;

         Maturity value will be £1,014,500.  

    e) Sell £1,014,500 forward for $1,542,040

    Arbitrage profit will be $12,040 

c. As per the, arbitrage transactions described above,

   Dollar interest rate will rise;

a) The spot exchange rate will rise;

b) The pound interest rate will fall;

c) These adjustments will continue until IRP holds.

d) The forward exchange rate will fall.

   Related Questions in Financial Accounting

  • Q : Importance of international financial

    Explain the importance in studying the international financial management?

    		•
  • Q : Analyse the ramifications for

    HOMEWORK ASSIGNMENT FOR ADMINISTRATIVE LAW"The problem in today's complex legal environment is that the law is not able to be divided conveniently into segments. Any apparently discrete sect

    		•
  • Q : Investment approach of Bill Miller

    Investment approach of Bill Miller: In comparison to both Warren Buffet and Peter Lynch, Miller is considered to be a slightly more aggressive investor.  Miller believed in playing big which meant that he used

    		•
  • Q : Cash flows in APV model State the

    State the intuition of discounting several cash flows in APV model at particular discount rates?

    		•
  • Q : Micro-level theories regarding cause of

    Identify and elucidate three micro-level theories about the cause of deviance.

    		•
  • Q : Matlab Applications in Control System

    Student faces a lot of difficulties in Matlab control system assignments and topics. If you are also having same issues and problems then www.tutorsglobe.com is the best available solution for you. We have highly skilled and experienced tu

    		•
  • Q : Progressives The progressives were

    The progressives were fascinated in “making people better.” What types of things were they fascinated in changing and who were they aiming their changes at?

    		•
  • Q : Interbank currency trading Explain, why

    Explain, why do most interbank currency trading globally include the U.S. dollar?

    		•
  • Q : Challenges of friendships How is

    How is friendship differing from other relationships? Explain the challenges of friendships. What are the common expectations for friendships – give an illustration of each. Explain how friendships fluctuate ove

    		•
  • Q : Japanese investments in the Southeast

    Japanese MNCs, like Toshiba, Toyota, Matsushita, and so on, made extensive investments within the Southeast Asian countries such as Malaysia, Thailand, and Indonesia. State your opinion, what forces are making Japanese investments within the region?

    		•