Economy Questions
Question Description
I’m working on a economics question and need guidance to help me learn.
1) Suppose the 5-year interest rate on a dollar-denominated pure discount bond (i.e., a bond that pays no coupon) is 4.5% per year, whereas in Spain the euro interest rate is 8% per year on a similar pure discount bond denominated in euros. If the current spot rate is $1.18/, what is the value of the forward exchange rate that prevents covered interest arbitrage?
2) Assume that today is June 1. You have been asked to help a British client who is scheduled to pay 1,500,000 on December 12, 194 days in the future. Assume that your client can borrow and lend pounds at an interest rate of 5% per year.
a. Describe the nature of your clients exchange risk.
b. What is the option cost for a December maturity and a strike price of £0.72/ to hedge the transaction? The option prices per 100 euros are £1.70 for calls and £2.40 for puts.
c. What is the maximum cost in pounds that your client will experience in December?
d. Determine the value of the spot rate (£/) in December that makes your client indifferent ex post to having done the option transaction or a forward hedge if the forward rate for delivery on December 11 is £0.70/. (assuming the same option prices for calls and puts)
Tags:
Economy
interest arbitrage
parity condition
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