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.By investing in U.K.treasury bills rather than U.S.treasury bills,and not covering exchange rate risk,U.S.investors earn an extra return of:
A) 4 percent per year,1 percent for the 6 months
B) 4 percent per year,2 percent for the 6 months
C) 2 percent per year,0.5 percent for the 6 months
D) 2 percent per year,1 percent for the 6 months

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.By investing in U.K.treasury bills rather than U.S.treasury bills,and not covering exchange rate risk,U.S.investors earn an extra return of:
A) 4 percent per year,1 percent for the 6 months
B) 4 percent per year,2 percent for the 6 months
C) 2 percent per year,0.5 percent for the 6 months
D) 2 percent per year,1 percent for the 6 months

Quizplus · Accepted Answer

If the U.S. investors invest in U.K. treasury bills with an 8 percent interest rate, they will earn an extra return of 4 percent per year compared to the 4 percent interest rate offered by the U.S. treasury bills. In six months, they would earn 2 percent, which is equivalent to $0.03 per pound ($1.50 - $1.485). Therefore, choice B is the correct answer, as it states U.S. investor can earn an extra return of 4 percent per year, which is equivalent to 2 percent for the six months.

Exhibit 11.1 Assume the Following