Interest rate parity
2. As the money manager of Boston Bank you have $1,000,000 available for six months. You have the opportunity to lend the fund in U.S. or lend the fund to prospective customers in Montreal or Landon.
Use the following information to answer this problem: (45Points)
- Present spot rate: $1.7120/£
- Six month forward rate: $1.6726/£
- Interest rate in U.S. is 8.00% annual
- Interest rate in U.K. is 10.5%
- Interest rate in Canada is 9.5%
a. Are interest rates and forward rates in equilibrium? Why or why not? Show your work.
b. Where should you invest for maximum yield?
c. What forward rate would create an equilibrium situation associated with investing in U.S. or Canada?
d. Would your decision about where to invest change if the U.K. interest rate was 15%?
e. If there is an arbitrage opportunity, for a transaction size of U.S. $1,000,000, (or £1,000,000) that you can borrow, how can you take advantage of the situation without taking undue risks? Show your work and profit or losses.
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|Interest xxxx xxxxxx|
|Amount available xxx 6 months||$1,000,000|
|Present spot rate:||$1.71||x£|
|x Six month forward xxxxx||xxxxx||/£|
|x Annual interest rate xx xxxx is||xxxxx|
|x Annual xxxxxxxx xxxx xx xxxx isx||xxxxxx|
|- xxxxxx interest rate in xxxxxx isx||xxxxx|
|a)||xxx interest rates and forward rates in xxxxxxxxxxxx Why xx xxx not? Show xxxx work.|
|xxx following equation xxxxxxxxxx xxxxxxxx rate parity|
|xx xxx xxxxxxxx future spot xxxxxxxx rate at xxxx t + x|
|x is xxx number xx xxxxxxx xxxx xxx future from xxxx x|
|St xx xxx current xxxx exchange rate xx time t|
|xx is xxx xxxxxxxx xxxx in the xx|
|xx is the xxxxxxxx xxxx in x xxxxxxx country xx currency area|
|xxx US $ xxx £|
|* 1.04x||=x||x 1.03|
|xxx interest xxxx xx U.K. xx|
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