FIN 4663 Solution to Problem 19.10 doc

FIN 4663 Solution to Problem 19.10 doc - • Enter into a...

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Problem 19.10 a) Lend in the UK b) Borrow in the U.S. c) According to the interest rate parity relationship learned in class the forward rate should be: Fo = Eo x 1x rf (US ) 1+ rf (UK) = 200 x 1.05 = 1.9626 Therefore the 1.07 forward rate of 1.97 is overpriced Strategy to arbitrage:
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Unformatted text preview: • Enter into a forward contract to sell P 1.07 at F0 $1.97 =(1.07 x 1.97 = $ 2.1079 • Borrow $2 in the US at 5% ( -$2.00x 1.05 = -$2.10) • Convert borrowed dollars into pounds at 1 Pound per US ($) and invest at 7% • Net profit: $2.1079 - $2.10 = 0.079...
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This note was uploaded on 03/05/2011 for the course FIN 4663 taught by Professor Martinez during the Fall '10 term at FIU.

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