Your company has to make a USD1m payment in three months' time. The dollars are available now. You decide to invest them for three months and you are given the following information:
- the US dollar deposit rate is 8 per cent p.a.;
- the sterling deposit rate is 10 per cent p.a.;
- the spot exchange rate is GBP1 = USD1.80; n the three-month forward rate is GBP1 = USD1.78.
(a) Where should your company invest for the better return?
(b) Assuming that interest rates and the spot exchange rate remain as above, what forward rate would yield an equilibrium situation?
(c) Assuming that the US dollar interest rate and the spot and forward rates remain as in the original question, where would you invest if the sterling deposit rate were 14 per cent per annum?
d) With the originally stated spot and forward rates and the same dollar deposit rate, what is the equilibrium sterling deposit rate?