QUESTION TWO a. Briefly evaluate the factors that may prevent the purchasing power parity from holding in real economies. b. Assume the following information: £ Spot rate = C5.20/€ 12-month forward rate = C6.00/£ C Interest rate = 26% per annum U.K. interest rate = 2% per annum i. Given the information above, does interest rate parity hold? What should be the 12- month forward rate, if interest rate parity holds? ii. How can an investor profit from this anomaly if she can easily borrow the equivalent of £1 million in either pounds or cedis to invest? How much profit can she make?
QUESTION TWO a. Briefly evaluate the factors that may prevent the purchasing power parity from holding in real economies. b. Assume the following information: £ Spot rate = C5.20/€ 12-month forward rate = C6.00/£ C Interest rate = 26% per annum U.K. interest rate = 2% per annum i. Given the information above, does interest rate parity hold? What should be the 12- month forward rate, if interest rate parity holds? ii. How can an investor profit from this anomaly if she can easily borrow the equivalent of £1 million in either pounds or cedis to invest? How much profit can she make?
Chapter5: Currency Derivatives
Section: Chapter Questions
Problem 32QA
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Transcribed Image Text:QUESTION TWO
a. Briefly evaluate the factors that may prevent the purchasing power parity from holding in
real economies.
b. Assume the following information:
£ Spot rate = C5.20/€
12-month forward rate = C6.00/£
C Interest rate = 26% per annum
U.K. interest rate = 2% per annum
i. Given the information above, does interest rate parity hold? What should be the 12-
month forward rate, if interest rate parity holds?
ii. How can an investor profit from this anomaly if she can easily borrow the equivalent
of £1 million in either pounds or cedis to invest? How much profit can she make?
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