Calculate the no-arbitrage price of a forward contract

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Reference no: EM133251862

Question - Suppose that you are a U.S.-based importer of goods from the United Kingdom. You expect the pound's value to increase against the U.S. dollar over the next 90 days. You will be paying 1,000,000 GBP on a shipment of imported goods in 90 days and want to hedge your currency exposure. The U.S. risk-free rate is 5.5 percent (annual), and the U.K. risk-free rate is 4.5 percent (annual). These rates are expected to remain unchanged over the next months. The current spot rate is $1.50/GBP.

a. Indicate whether you should use a long (buy) or short (sell) forward contract to hedge currency risk.

b. Calculate the no-arbitrage price of a forward contract that expires in 3-months.

c. Suppose that after doing the calculation in part b, you call Bank of America and ask for a quote for a GBP forward contract. You are offered the following 3-month Forward Rate= $1.60/GBP. Would you sign the Forward contract with Bank of America at that quoted rate? Yes, or no? Justify your answer.

Reference no: EM133251862

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