Suppose that the U.S. dollar-pound sterling spot exchange rate equals $1.60/£, while the 360- day forward rate is $1.64/£. The yield on a one-year U.S. treasury bill is 9 percent and that on a one-year UK treasury bill is 8 percent. Calculate the covered interest differential in favor of London. On the basis of this result, which country would you expect to have capital inflows and which to have capital outflows?
Added by Eric F.
Step 1
- Spot exchange rate, \( S_0 = 1.60 \) USD/£ - Forward exchange rate, \( F = 1.64 \) USD/£ (360-day forward) - U.S. interest rate, \( i_{US} = 9\% \) per year - UK interest rate, \( i_{UK} = 8\% \) per year --- Show more…
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At present, the dollar is trading against the British pound at spot GBP/USD = 1.1517, and at one-year (365-day) forward at 64 forward points. One-year (360-day) eurodollar deposits for the U.S. dollar is 5.39%, while half-year (180-day) eurosterling is 4.11%. Using the covered interest parity condition, determine if: (a) there is an arbitrage opportunity (hint: be sure to pay attention to the difference between the tenor of the forward versus that of deposits); (b) explain how you may exploit this opportunity, if any?
Akash M.
Due to the integrated nature of their capital markets, investors in both the United States and the U.K. require the same real interest rate, 2.5 percent, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3.5 percent in the United States and 1.5 percent in the U.K. for the next three years. The spot exchange rate is currently $1.50/£. a. Compute the nominal interest rate per annum in both the United States and the U.K., assuming that the Fisher effect holds. b. What is your expected future spot dollar-pound exchange rate in three years from now? c. Can you infer the forward dollar-pound exchange rate for one-year maturity?
Assume the following information: Spot rate of £ = $1.60 180-day forward rate of £ = $1.56 180-day British interest rate = 4% a. Based on this information, is covered interest arbitrage by US investors is possible (assuming that U.S. investors have $1,000,000)? If yes, Explain how to conduct it in your words. b. Suppose: 180-day US interest rate = 3%. Is the above strategy is feasible? Explain your answer
Cameron B.
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