If you invest $100,000 in the British pound market for six months with a forward cover...

If you invest $100,000 in the British pound market for six months with a forward cover when the interest rate and exchange rates are as shown below, your annualized rate of return from the investment is 3%. Spot rate: $1.3050-60£/; Ft+6 = $1.2975-90£/; i£ = 4.20% a) True b) False Answer: b.

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Expert Solution

The annualized rate of return is calculated as below :

Convert $100,000 into £ today. £ received = $100,000 / 1.3060 = £76,569.68
Invest the £ received at the £ interest rate for 6 months. £ received after 6 months = £76,569.68 * 4.2% * (6/12) = £78,177.64
Using the forward contract, convert the £ received after 6 months into $. $ received after 6 months = £78,177.64 * 1.2975 = $101,435.49
Annualized rate of return = (($101,435.49 - $100,000) / $100,000) * (12 / 6)
Annualized rate of return = 2.87%

(b) - False

jeff jeffy answered 2 years ago

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