An investor can borrow $904,900 or equivalent pound. The current spot exchange rate is $2.0841/Pound, and the one-year forward rate is $1.9864/Pound. If a one-year interest rate in the US is 9.29%, the UK rate is 17.33%, what is the covered interest arbitrage profit?

Group of answer choices

2.5397%

1.4730%

2.6159%

3.0731%

2.0064%

The interest rate policy followed by the Central Bank of major world economies (USA, UK, Japan, Europe) are near zero or negative. Discuss the implication this low-interest rate policy for any one type of financial institution (banks, savings, and loans, insurance companies, pension funds, mutual funds, etc.) and examine its possible impact.

How much is your arbitrage profit in Euros at expiration, if you know that the current exchange rate is Euro 1.2 / GBP, the 60-day forward rate is Euro 1.16 /GBP, the risk free rate in Europe is 2% and the risk free rate in the UK is 4%? Make your calculation so that the spot transaction is for GBP 500,000.

1. The risk-free rate in the US is 5% and the UK risk-free rate is 8%. The spot quote is $1.80/£ while the one year forward quote is $1.78/£. You can borrow either $1,000,000 or £555,556. According to IRP, is the forward quote correct? If not, what should it be?

If the forward quote is not correct, lay out the steps to implement an arbitrage.

As a risk manager for XYZ corporation, you are assessing the firm’s various risk exposures to include in a regular semi-annual report to upper management.

XYZ is a medium-size import/export firm located in Cambridge, UK. Its primary sources for imports, which it sells in the UK and Eurozone, are located in China and Vietnam. It has customers throughout the world, but more than half of its exports go to Africa. XYZ customarily borrows to cover funds tied up in exports.

Further, XYZ has recently launched its own online B2B (Business-to-Business) platform.

Q1. Identify seven types of risk exposures you should report and provide a brief explanation for each risk exposure.

Q2. Suppose the firm’s board needs your views on the trade-off of hedging against the identified risks.

Briefly discuss what kind of value can be generated by risk hedging, when risk hedging is most likely to generate value and when it is least likely to do so.

You have been presented with the option of investing in either Bond #1 or Bond #3 issued by the same UK corporation. Bond #1 and Bond #3 are equal in every respect (i.e. both are 3-year 6.5% coupon bonds), except that Bond #3 has a put option embedded in it. The following are the bonds’ Z-spreads over the UK term structure.

Bond #1: Z-spread = 4.65%

Bond #3: Z-spread = 4.05%

Your broker informs you that Bond #3 is a more attractive investment because, based on its option-adjusted spread (OAS), its option spread is .85% a. What are the option-adjusted spreads (OAS) for Bond #1 and Bond #3? Do you agree with your broker?

Suppose your broker informs you that the option-adjusted spreads (OAS) in part a. was computed using an assumed interest rate volatility of 10%, how would the OAS in part a. be affected if a 5% interest rate volatility is assumed?