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If you borrow S dollars at r interest rate for one period, purchase 1/S pounds and invest them in UK Treasuries at a rate g for the period, then sell the proceeds for delivery forward at F dollars per pound at the end of the period, at which time you payoff your loan:

a) What is your cost of carry?

b) How much should you gain in order to just offset your cost of carry?

c) Consequently, in equilibrium, what is the no-profit arbitrage condition (also known as interest rate parity)?

Microeconomics, Economics

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