Using descriptive and numerical illustration, make a distinction between spatial and triangular arbitraging in the context of foreign exchange market.
Derive and illustrate out the interest rate parity theorem and its implications.
One year borrowing and deposit interest rates are 12.6% and 10.5% respectively in US and 10.4% and 8.75% respectively in Germany. The spot exchange rate for US dollars is $15 to the EURO. The 12-month forward rate is $15.73. The economies are pegged together, and have been so for a number of years.
i) Suggest a way you may profit from the pricing inconsistency that is presented here, supposing you have no initial investment funds.
ii) Will the situation persist forever? Illustrate out your answer.
iii) What should be the spot rate which would bring a no-arbitrage situation?
Discuss and illustrate out the benefits of international diversification and describe the issue of home country’s bias in equity and bonds markets.
Derive and illustrate out the currency hedged returns on equity bond portfolios. How do the above returns change when the porfolios are unhedged?