You have $2,000. The current interest rates on dollar and pound denominated deposits for 180 -day maturity are i$ = XXXXXXXXXX%) and i£ = XXXXXXXXXX%), respectively. The current spot exchange rate is e = $2/£1.
a. What are your three basic choices of strategy over the next 180 days?
b. If you (and everyone else) were certain that the exchange rate between dollars and pounds would not change over the next 180 days, what would you do? What would you have at the end of 180 days?
c. Assume that you do not mind bearing foreign exchange risk. You expect the spot rate in 180 days to be $1.90/ £1. What strategy would you follow, and why? After 180 days, the actual spot rate turns out to be $1.80/£1. Are you pleased with your decision? Why or why not?
d. Now assume you are risk averse. The 180-day forward rate is $2.02/£1. What strategy would you follow?
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