QUESTION 11 Assume the following information British investo

QUESTION 11 Assume the following information: British investors have 1,200,000 pounds to invest: 1-year deposit rate offered by U.S. banks- 1-year deposit rate offered by British banks 1-year forward rate of pound Spot rate of pound 8% 13% $1.12 $1.50 Given this information, if a British investor conducts a covered interest arbitrage, how much pounds will he have at the end of the investment? 2,177,280 None of the answers provided is correct 1,296,000 1,735,714 1,816,071

Solution

Covered Interest arbitrage is an oppurtunity where we can use the Current and forward rates with the forex investment and try to earns a riskless profit.

In the given case British Investors has 1,200,000 Pounds today and he want to use the Covered Interest Arbitrage.

STEP 1: Convert the Pound into Dollars today.

Current Exchange rate is 1 pound = $1.50.

Hence For 1,200,000 Pounds We get (1,200,000 * 1.50) i.e. $1,800,000

STEP 2: Invest $1,800,000 in U.S. Banks @ 8%.

So inflow from Investment after 1 year will be = ($1,800,000 * 1.08) i.e. $1,944,000

STEP 3: At the Same time we also buy 1year forward rate for $1,944,000.

Hence 1year Forward rate is 1 pound = $1.12

So Inflow We have in Pounds after 1 year = ($1,944,000 / 1.12) i.e. 1,735,714 Pounds.

Hence the option will be D) 1,735,714

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