Exhibit 11.1 Assume the following:
(1) the interest rate on 6-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 6-month forward price of the pound is $1.485.
-Refer to Exhibit 11.1.If U.S.investors cover their exchange rate risk,the extra return for the 6 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 6-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 6-month forward price of the pound is $1.485.
-Refer to Exhibit 11.1.If U.S.investors cover their exchange rate risk,the extra return for the 6 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

The extra return is the difference between the interest rate on the U.K. treasury bills and the interest rate on the U.S. treasury bills, adjusted for the forward premium or discount. In this case, the interest rate on the U.K. treasury bills is 8% and the interest rate on the U.S. treasury bills is 4%. The forward premium is calculated as (1.50 - 1.485) / 1.485 = 1%. Therefore, the extra return is 8% - 4% - 1% = 3%.

Exhibit 11.1 Assume the Following