Suppose that the risk-free rates in the United States and in the United Kingdom are 6% and 4%,respectively.The spot exchange rate between the dollar and the pound is $1.60/BP.What should the futures price of the pound for a one-year contract be to prevent arbitrage opportunities,ignoring transactions costs.
A)$1.60/BP
B)$1.70/BP
C)$1.66/Bp
D)$1.63/BP
E)$1.57/BP

Question

Quizplus · Accepted Answer

The futures price of the pound should reflect the interest rate differential between the US and the UK. In this case, the difference is 2% (6% - 4%). This means that the pound should be priced at a premium relative to the spot exchange rate. The formula for calculating this premium is:

F = S x (1 + rfc)/(1 + rfc)

where F is the futures price, S is the spot exchange rate, rfc is the risk-free rate in the foreign country (US in this case), and rdc is the risk-free rate in the domestic country (UK in this case).

Plugging in the numbers, we get:

F = $1.60/BP x (1 + 0.06)/(1 + 0.04) = $1.63/BP

Therefore, the correct answer is D) $1.63/BP.

Suppose That the Risk-Free Rates in the United States and in the United