Consider a US investor with $1000 to place in a bank deposit either in US and Great Britain. The one-year interest rate on bank deposits is 5% in GB and 1% in US. The one-year forward dollar-pound exchange rate is 1.2575 dollars per pound and the spot rate is 1.25 dollars per pound.
(a) What is dollar denominated return on US deposits?
(b) What is the riskless dollar-denominated return on British deposit using forward cover?
(c) Is there an arbitrage opportunity?
(d) According to CIP, what should be the equilibrium forward exchange rate?