Your company has to make a US $1 million payment in three months’ time. The dollars are available now. You decide to invest them for three months and you are given the following information:
The US deposit rate is 8% per annum.
The sterling deposit rate is 10% per annum.
The spot exchange rate is $1.80/£
The three-month forward rate is $1.78/£
(a) Where should your company invest to get the better return?
(b) Assuming that interest rates and the spot exchange rate remain as above, what forward rate would yield an equilibrium situation?
(c) Assuming that the US $ interest rate and the spot and forward rates remain as in the original question, where would you invest if the sterling deposit rate were 14% per annum.
(d) With the originally stated spot and forward rates and the same dollar deposit rate, what is the equilibrium sterling deposit rate?