Questions:
1. Discuss the implications of the interest rate parity for the exchange rate determinants.
2. You are invited to a seminar and asked to present briefly about ”arbitrage”. Provide an explanation with some examples in the foreign exchange
market.
3. While you were visiting London, you purchased a Jaguar for £35,000, payable in three months. You have enough cash at your bank in New York City, which pays 0.35% interest per month, compounding monthly, to pay for the car. Currently, the spot exchange rate is $1.45/£ and the three-month forward exchange rate is $1.40/£. In London, the money market interest rate is 2.0% for a three-month investment. There are two alternative ways of paying for your Jaguar.
a. Keep the funds at your bank in the U.S. and buy £35,000 forward.
b. Buy a certain pound amount spot today and invest the amount in the U.K. for three months so that the maturity value becomes equal to £35,000 Evaluate each payment method. Which method would you prefer? Why?
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