Which of the following is true if one year forward rate is F = 1.83$/£; current spot rate is S = 1.81$/£; and interest rates are i = 3.5%,and i* = 3% (where exchange rates are quoted in $/£,i is the interest rate in the U.S.and i* is the interest rate in the U.K.)?

Question

Quizplus · Accepted Answer

If the forward rate is greater than the expected future spot rate, then there is a possibility for arbitrage profit. Here, the forward rate is higher than the expected future spot rate (1.81 x (1 + 3%) = 1.8623), so there is an opportunity for arbitrage. To benefit from the arbitrage, an investor should sell £ forward at the 1-year forward rate of $1.83/£. This is because they can lock in a profit of ($1.83 - $1.81) = $0.02 per £. Consequently, the arbitrage strategy involves selling £ forward.

Which of the Following Is True If One Year Forward