The US 1-year interest rate is 5% per year and the 1-year UK interest rate is...

Question

Question

The US 1-year interest rate is 5% per year and the 1-year UK interest rate is 3%. The spot rate is $1.55/pound and the 1-year forward rate is $1.60/pound.
1. The optimal strategy is for an investor to borrow pounds because the pound is at a forward premium
2. The optimal strategy is for an investor to borrow dollars
3. Interest Rate Parity holds, so there is no advantage to borrowing dollars or pounds
4. The optimal strategy is to borrow pounds because UK interest rates are lower

Answer 1

Answer #1

forward rate should be=1.55*(1+5%)/(1+3%)=1.580097087

pound is at forward premium
But as rate is more than theoretical rate
pound is overvalued hence one should sell pound forward and borrow dollar

The optimal strategy is for an investor to borrow dollars

Answer 2

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