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- 2013-8-23
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Guys, I need some help on this topic too, on reading 54 Example 5:
Problem:
The Spot rate for British Pounds is $1.76. The U.S. risk free rate is 5.1%, and the U.K risk-free rate is 6.2%. both are componded annually, one year forward contracts are currently quoted at a rate of $1.75.
Question:
Identify a strategy with which a trade can earn a profit at no risk by engaging in a forward contract, regardless of her view of the pound’s likely movements. Cafully describ the transactions the trader would make . Show the rate of return that would be earned from this transaction. Assume the trader’s domestic currency is US dollars.
Answer:
foward rate= $1.76/1.062*1.051=$1.7418
With the forward contract selling at $1.75, it is slighly overpriced. Thus, the trader should be able to buy the currency and sell a foward contract to earna return in excess of the risk-free rate at no risk. the specific transactions are as follows:
1. take $1.76/1.062=$1.6573. Use it to buy 1/1.062= 0.9416 pounds
2. sell a fowrad contract to deliver 1 pound in one year at the price of &1.75
3. hold the position fo one year, collecting interest at the U.K. risk free rate of 6.2%. The 0.9416 pound will grow to 0.9416*1.062=1 pound
4. at expiration, deliver the pound and receive $1.75. This is a return of 1.75/1.6573 - 1=0.0559
my confusion:
1. what does $1.76/1.062 represent? I understand foward rate= $1.76/1.062*1.051=$1.7418, but what does $1.76/1.062 represent?
2. “Use it to buy 1/1.062= 0.9416 pounds”, what does this represent? use 1 pound devide by rate in UK risk free rate? what does this really mean?
CAN SOME ONE HELP ME PLZZZ? |
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发表于 2013-4-28 10:12
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