2. You are asked to prepare a quote in US dollars on the forward price you would charge for the delivery in 9 months of a British bond with a face value of £1000 and semiannual coupons of 10% per annum. The UK and US yield curves are quoted in the following schedule of simple and continuously compounded interest rates. The spot exchange rate is $2.4 per £:
Maturity in years UK Simple interest rate US Continuously compounded rate
.5 5.0% 3.2%
.75 5.25% 3.3%
1.0 5.5% 3.45%
(a) Determine the price in pounds of the British bond.
(b) Determine the amount borrowed in US dollars to implement the replication strategy of buying the British bond in the spot market andselling intermediate incomes.
(c) Determine the US dollar forward price quote.
(d) Determine the forward price for the same British bond in the UK in
pounds.
(e) Determine the forward exchange rate for 9 months.
(f) Determine the dollar cost of buying the bond forward in the UK using
the 9 month forward exchange market.
(g) Compare your answers to c andf and describe the arbitrage if the
answer to c was below that in f: