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Please help me solve sums on foreign exchange

CA Final 572 views 1 replies

Shruti

34 Points Posted on 27 February 2014

The U.S. risk-free rate is 5.1 %, and the UK risk-free rate is 6.2%; both are compounded annually. The spot rate of British pounds is $1.76. One-year forward contracts are currently quoted at a rate of $1.75.

Identify a strategy with which a trader can earn a profit at no risk by engaging in a forward contract, regardless of her view of the pounds like movements. Carefully describe the transactions the trader would make. Show the rate of return that would be earned from this transaction. Assume the trader’s domestic currency in US dollars.
Suppose the trader simple shorts the forward contract. It is now one month later. Assume interest rates are the same, but the spot rate is now $1.72. What is the gain or the loss to the counterparty on the trade?
At expiration, the pound is at $1.69. What is the value of the forward contract to the short at expiration?

Replies (1)

ganesh narayanan

article

36 Points Posted on 03 March 2014

hi,

QUESTION A is a question on covered interest arbitrage,take the forward rate as future spot rate and find the theoretical riskfree rate in home country.if actual rate>theoretical then borrow in foreign country and invest in home country.if theoretical>actual rate then vice versa.

question B

find the future spot rate using interst rate parity theory using given spot rate and find the gain or loss in forward if we enter to sell forward

Question C the rate given in the question is fduture spot rate using that find gain or loss in forwad if it is entered to sell

if the rate in market fall compared to rate we entered in forward it is gain as we entered to sell

if the rate raises then loss