If F/S (1 + i)/(1 + i*)(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.),which of the following is true?

Question

If F/S > (1 + i)/(1 + i*)(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.),which of the following is true?

Quizplus · Accepted Answer

If F/S > (1 + i)/(1 + i*), it indicates that the forward rate is overpriced relative to the interest rate differential. Arbitrage is possible by borrowing in the currency with the lower interest rate (U.K.), converting to the currency with the higher interest rate (U.S.), and selling £ forwards to lock in the profit.

If F/S > (1 + I)/(1 + I*)(where Exchange Rates