An exchange dealer has $1 million for a short-term money market investment. That is, he wants minimal risk in his investment, but he still wants to maximize the available return. Given the following market rates in the U.S. and London, what would you recommend? Why? And what is the annualized rate of return for your recommended investment?
Spot exchange rate £1.2810/$
3-month forward rate £1.2740/$
3-month U.S. interest rate 4.800% p.a.
3-month £ rate 3.200% p.a.
*Note: p.a. stands for per annum, meaning the annualized rate. Assume that 3-months represents exactly one-fourth of the year and make the necessary conversion.