Calculate the forward premium on the british pound

Assignment Help Business Economics

Reference no: EM1354983

Consider a Dutch investor with 1000 euros to place in a bank deposit in either the Netherlands or Great Britain. The (one-year) interest rate on bank deposit is 2% in Britain and 4.04% in the Netherlands. The (one year) forward euro-pound exchange rate is 1.575 euros per pound and the spot rate is 1.5 euros per pound. Answer the following questions, using the exact equations for UIP and CIP as necessary.

a. What is the euro-dominated return on Dutch deposits for this investor?
€1000 * 1.0404 = €1040.40

b. what is the (riskless) euro-dominated return on British deposits for this investor using forward cover?
€1000 * 1/1.5 * 2% =£ 680 = 680 * 1.575 = €1071.00

c. Is there an arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market?

d. If the spot rate is 1.5 euros per pound, and interest rate are as stated previously, what is the equilibrium forward rate, according to CIP?

e. Suppose the forward rate takes the value given by your answer to (d). Calculate the forward premium on the British pound for the Dutch investor (where exchange rates are in euros per pound). Is it positive or negative? why do investors require this premium/discount in equilibrium?

Reference no: EM1354983

Questions Cloud

Explain what analysis did the tennessee appeals court use : Explain What analysis did the Tennessee Appeals Court use to distinguish between a partnership and a joint venture?

How much work is done by the clerk : What average force is required to accelerate 7 gram pellet from rest to 125 m/s over a distance of .8 m along the barrel of a rifle.

Organizational behaviors and intellectual capital : Organizational Behaviors and Intellectual Capital - What is the importance of organizational behaviors on the value of intellectual capital?

Audit-segregation of duties : Explain the control principle of independent internal verification. What practices are important in applying this principle?

Calculate the forward premium on the british pound : Calculate the forward premium on the British pound for the Dutch investor where exchange rates are in euros per pound. Is it positive or negative? why do investors require this premium/discount in equilibrium.

State and federal laws regarding working with human subjects : Stanford Prison Experiment, which is one of the unethical studies that inspired the APA guidelines and state and federal laws regarding working with human subjects we have in place today.

Organizational controls within general motors currently : What different kinds of organizational controls are functioning within General Motors currently?

Purchasing a lifetime subscription : Your subscription to Jogger's World is about to run out and you have the choice of renewing it through sending in the $10 a year regular rate at the end of each year or of getting a lifetime subscription to the magazine through paying $100 today.

Explain how to generate array of random numbers : For some general variables L and U, write a comment that explains how to generate a 1 x N array of random numbers whose values are between L and U.

User Account

All Pages