--%>
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 : Why depreciation is not charged on land

    Explain why depreciation is not charged on land?

    		•
  • Q : Shadow balance Define the terms shadow

    Define the terms shadow balance?

    		•
  • Q : Introduction of the term Financial

    Give a brief introduction of the term ‘Financial Accounting’. And also write down its elements?

    		•
  • Q : Explain Cost of goods Explain Cost of

    Explain Cost of goods and how they are used in estimating gross profit and net profit of the business?

    		•
  • Q : Small talk Define small talk and

    Define small talk and discuss its role in developing the relationship.

    		•
  • Q : Implement a user-defined matlab

    Your solution to the problem should be housed within a while loop, which allows the grader to test your solution repeatedly without having to re-execute the script, as shown in class. You should first display the purpose of the program, and then you should prompt the

    		•
  • Q : Discrimination to women and minority

    Most of the organizations have established policies to remedy discrimination whenever hiring women and minorities. Discuss whether you feel that affirmative action programs, reverse discrimination, and criteria of comparable worth are suitable forms of remedy. You mus

    		•
  • Q : Matlab Applications in Digital Signal

    Digital signal processing appears like a nightmare for students as it is most difficult and tricky subject in engineering core curriculum. If you are getting troubles in digital signal processing assignment or related project, then move

    		•
  • Q : Cash flows from operating activities A

    A financial analysis tools that measures the need for financing. The formula is the cash-flow from operating activities divided by the cash paid for long-term asset. Cash paid for long-term assets can be found on the statement of cash-flow, in the investing-activities

    		•
  • Q : Goals of Social Democrats What were the

    What were the goals of Social Democrats? What did Anarchists want?

    		•