Assignment

1. Assume the interest rate of 1-year risk free debt denominated in US dollars is 1.04% and the interest rate on 1-year risk free debt denominated in euros is 0.85%, if today's spot market exchange rate for euros is 1.0770, what is the 1-year forward exchange rate if interest rate parity holds?

2. If the actual 1-year forward exchange rate for euros is 1.0783 and the spot market exchange rate and interest rates are as indicated in question 1, what trades should you make to take advantage of the arbitrage opportunity? Be specific about both current and future transactions (i.e., be sure to specify what currency/currencies are involved and how, and the amount of each - you can make any assumption you like about the amount of currency to start).

[Note: Immediate transactions will include: borrowing one currency at its risk free rate, exchanging it for the other currency, investing the currency received at its risk free rate, and entering a long or short forward contract to exchange the proceeds of the investment for the currency borrowed. Transactions in one year will include: closing out the investment, selling the currency received on sale of the investment at the forward price and using the proceeds to.repay the loan.]

b. How profitable is the trip trade? (State the profitability, either in dollars or euros and as a percent of initial amount borrowed.)

3. Assume the interest rate on 6-month risk free debt denominated in US dollars is 0.75%, the interest rate on 6-month risk free debt denominated in Indian rupees is 6.75%, if today's spot market exchange rate for the rupee (USDINR) is 67.34, what must the 6-month forward rate on the rupiah be if interest rate parity holds?

4a. If the 6-month forward exchange rate for the Indian rupee 69.515 and the spot market exchange rate and interest rates are as indicated in question 3, what trades should you make to take advantage of the arbitrage opportunity? Be specific about both current and future transactions (i.e., be sure to specify what currency/currencies are involved and how, and the amount of each - you can make any assumption you like about the amount of currency to start).

[Note: Immediate transactions will include: borrowing one currency at its risk free rate, exchanging it for the other currency, investing the currency received at its risk free rate, and entering a long or short forward contract to exchange the proceeds of the investment for the currency borrowed. Transactions in one year will include: closing out the investment, selling the currency received on sale of the investment at the forward price and using the proceeds to.repay the loan.]

b. How profitable is the trip trade? (State the profitability, either in dollars or rupees and as a percent of initial amount borrowed.)