Exhibit 11.1

Assume the following: (1) the interest rate on six-month treasury bills is 8 percent per annum in the United Kingdom and 4 percent per annum in the United States; (2) today's spot price of the pound is $1.50, while the six-month forward price of the pound is $1.485.

-Refer to Exhibit 11.1.If U.S.investors cover their exchange rate risk, then the extra return for the six months on the U.K.treasury bills is
A) 1.0 percent.
B) 1.5 percent.
C) 2.0 percent.
D) 2.5 percent.

Question

Exhibit 11.1

Assume the following: (1) the interest rate on six-month treasury bills is 8 percent per annum in the United Kingdom and 4 percent per annum in the United States; (2) today's spot price of the pound is $1.50, while the six-month forward price of the pound is $1.485.

-Refer to Exhibit 11.1.If U.S.investors cover their exchange rate risk, then the extra return for the six months on the U.K.treasury bills is
A) 1.0 percent.
B) 1.5 percent.
C) 2.0 percent.
D) 2.5 percent.

Quizplus · Accepted Answer

To calculate the extra return for the six months on the U.K. treasury bills for U.S. investors covering their exchange rate risk, we first determine the interest rates and adjust for the forward rate to cover exchange rate risk. The U.K. interest rate is 8% per annum, which is 4% for six months. The U.S. interest rate is 4% per annum, which is 2% for six months. The forward discount on the pound is calculated as (1.50 - 1.485) / 1.50 = 0.01 or 1%. Therefore, the extra return is the difference between the U.K. interest rate for six months and the sum of the U.S. interest rate for six months plus the forward discount, which is 4% - (2% + 1%) = 1%.

Exhibit 11.1 Assume the Following: (1) the Interest Rate on Six-Month Treasury