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26 March, 09:53

The current rates are: (1) Spot exchange rate: $2.00/£; (2) 90-day USD denominated bonds: 2% (8% annual); (3) 90-day UK pound denominated bonds: 4% (16% annual); (4) Current 90 day forward exchange rate: $1.98/£ Is the Pound trading at a premium or discount?

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  1. 26 March, 10:18
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    Solution and Explanation:

    Assume US Investor need 1000 Pound after 90 days:

    Option 1: Forward Option:1000 pound = 1000 multiply with 1.98 = $1980

    Option 2: Invest in UK:

    Need 1000 pound after 90 days

    so, Invest in UK pound today 1000 divide by 1.04 = 961.5385

    to get 961.5385 today he need to pay = 961.5385 multiply with $2 (Current Spot Rate)

    = $1923.077

    Option 3 : Invest in US:

    Need 1000 Pound after 90 days

    so forward Exchange rate 1.98 he need 1000 pound * 1.98 = 1980 $ after 90 days

    so invest today 1980/1.02 = $1941.176

    Advise: Option 2 is best, Invest in UK Bonds
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