1. Suppose an investor invests in a savings account in England one year ago.At the time of investment, the investor converted $100,000 to pounds at an exchange rate of 1.404$/£.
Assume the interest rate in England was 3% and today the investor is converting his/her savings balance (principal plus interest) to dollars when the exchange rate is 1.464$/£. Assume that today the exchange rate is 1.464$/£ and that the 6-month interest rate in London is 3.2% p.a. while the 6-month interest rate in the U.S. is 2.8% p.a.
What would you expect the 6-month forward rate to be at this time?
Remember to adjust for the 6-month period. Show your work
3. Again, working with interest rate parity, Let's assume that the spot exchange rate between Mexican pesos (P) and the U.S. dollar is 18.8679 P/$ and the 1-year forward rate is 19.1679 P/$.Also assume that the U.S. interest rates are 2% p.a. and the Mexican interest rates are 1.95% p.a.
What actions can an arbitrageur take to profit per $1000 invested from this scenario?
Specifically note the actions the arbitrageur would take and then report the arbitrage profit available per $1000 because interest rate parity is not holding.
Note that an arbitrageur would invest as much money as available (millions) given this scenario so huge arbitrage profits could be made.