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HW 2 Solutions

# HW 2 Solutions - Suggested Solution to HW 2 Slide 14 of...

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1 Suggested Solution to HW 2 Slide 14 of Lecture 3 : The market conditions are summarized as follows: i \$ = 3%; i £ = 2.49%; S = \$2/£; F 360 (\$/£)=??? If F 360 (\$/£) > \$2.01/£, then (1 + i \$ ) < ( F \$/ £ / S \$/ £ )(1 + i ). Thus, the trader can arrange the following transactions to make profit: 1. Borrow \$1,000 at t = 0 at i \$ = 3%. 2. Exchange \$1,000 for £500 at the prevailing spot rate (note that £500 = \$1,000 ÷ \$2/£); invest £500 at 2.49% ( i £ ) for one year to achieve £500×(1+2.49%)=£512.45. 3. Sell the £512.45 in forward at F 360 (\$/£) to translate pounds back to dollars: £512.45× F 360 (\$/£). If F 360 (\$/£) > \$2.01/£, then £512.45 will be more than enough to repay your debt of \$1,000×(1+3%)=\$1,030. Similarly, if F 360 (\$/£) < \$2.01/£, then (1 + i \$ ) > ( F \$/ £ / S \$/ £ )(1 + i ). Thus, the trader can arrange the following transactions to make profit: 1. Borrow £500 at t = 0 at i £ = 2.49%. 2. Exchange £500 for =£500×\$2/£ =\$1,000 at the prevailing spot rate; invest \$1,000 at 3% for one year to achieve \$1,000×(1+3%)=\$1,030. 3. Buy the forward at F 360 (\$/£) to translate \$1,030 back into pounds: \$1030/ F 360 (\$/£); if F 360 (\$/£) < \$2.01/£, then \$1,030 will be more than enough to repay your debt of £500×(1+2.49%)= £512.45. Problem 6.1 : The market conditions are summarized as follows: i \$ = 4%; i = 3.5%; S = €1.01/\$; F = €0.99/\$. If \$100,000,000 is invested in the U.S., the maturity value in six months will be \$104,000,000 = \$100,000,000 × (1 + .04). Alternatively, \$100,000,000 can be converted into euros and invested at the German interest rate, with the euro maturity value sold forward. In this case the dollar maturity value will be

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HW 2 Solutions - Suggested Solution to HW 2 Slide 14 of...

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