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Problem
1. Suppose the spot rate of the pound today is $1.70 and the 3-month forward rate is $1.75.
a. How can a U.S. importer who has to pay 20,000 pounds in 3 months hedge her foreign-exchange risk?
b. What occurs if the U.S. importer does not hedge and the spot rate of the pound in 3 months is $1.80?
2. Suppose the interest rate (on an annual basis) on 3-month Treasury bills is 10 percent in London and 6 percent in New York, and the spot rate of the pound is $2.
a. How can a U.S. investor profit from uncovered interest arbitrage?
b. If the price of the 3-month forward pound is $1.99, will a U.S. investor benefit from covered interest arbitrage? If so, by how much?
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