Suppose you are given the following financial information onJanuary 1, 2020:
Spot $/£ exchange rate(e):                                       $1.20/£
One-year interest rate on dollars(iUS):Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 2.0%
One-year interest rate on pounds(iUK):Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 6.0%
Market’s expected spot rate in oneyear(eex):           $1.12/£
- If a U.K. investor looking for the highest return agrees withthe market’s expectation of the future spot rate, should she makean uncovered investment in dollars or simply invest in pounds?
- If a U.S. firm will be receiving £1,000,000 in one year, andwants to eliminate any foreign exchange risk, what can the firm doin the money markets?
- A U.S. firm will be receiving £1,000,000 in one year, anddiscovers that forward contracts are available. Its bank quotes thefirm a forward rate of f = $1.15/£? What would the firm do toeliminate any foreign exchange risk using a forward contract?
D. Suppose there is still trading in the spot foreign exchangemarket today, but the market’s expected spot rate in one year isset at $1.12/£. What is the equilibrium spot rate in the markettoday at which uncovered interest rate parity holds?
