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Question 1
(i) The $/£ spot rate is $1.60/£1. The UK interest rate is 9% and the US interest rate is 6%. Calculate the one year forward rate using the covered interest parity formula and state whether the dollar is at a forward premium or discount. Show your calculations.
(ii) You are a hedge fund manager you observe the spot dollar per euro exchange rate is $1.50/€1 while the one year forward rate is $1.45/€1. You expect the rate to be $1.25/€1 in one year's time. You have either $14.5 million to buy or sell in the forward market.
(a) State if you buy or sell $14.5 million dollars forward.
(b) Calculate your profit in dollars and euros if you are right and the spot exchange rate is $1.25/€1 in a year's time. Show your calculations.
(c) Calculate your loss in dollars and euros if you are wrong and the spot exchange rate is $1.65/€1 in a year's time. Show your calculations.
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