1. The spot MXN/¥ FX rate is S0(MXN/¥) = MXN0.100/¥. The ¥ interest rate is 3.0% per annum and the MXN interest rate is 5.0% per annum, both quoted with annual compounding. Suppose that you observe a 9-month forward price of F0,0.75 = MXN0.101/¥. How would you make an arbitrage profit? Describe the steps and calculate the profit. (9 months = 0.75 years)
2. Suppose the current spot FX rate is S0(£/$) = £0.60/$. The consensus long-term forecast for US inflation is 5% per year, while the long-term forecast for UK inflation is 3%. By what percentage do you expect the spot rate to change over the coming year?