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Examine the spot rate and the six-month forward rate for the British pound. Suppose a speculator anticipates that the pounds spot rate and the six-month Eurodollar deposit rates will be unchanged from their present levels in six months time. However, at that future date, the six-month Euro-sterling deposit rates will have changed to 10.0000-10.0625% per annum. What should be the new six-month forward rate for the pound if covered interest arbitrage opportunities are to be avoided half a year from now? How can the speculator profit from the expected change in the interest rate difference while remaining in a square position (i.e., offsetting foreign exchange purchase contracts with sales contracts) at all times? What will be the expected dollar profit per pound? How will this expected profit change if the spot rate six months later does not remain constant but changes to 1.5500 /10? To 1.4500 /10? What circumstances might cause the speculator to realize a loss rather than a gain?

Exhibit l Spot and Forward Exchange Rates Spot 1 Month 3 Months 6 Months 12 Months Currency Sterlinga 1.4890/00 55/52 160/156 302/289 560/523 Deutsche mark 2.0310/20 22/18 64/54 128/105 277/228 French Franc 6.6575/625 73/86 263/296 505/590 1194/1351 Yen 154.20/30 8/6 33/27 75/62 164/137 SDR 1.2141/43 5/3 12/8 18/11 24/12 au.S. dollars per unit of currency. Exhibit 2 Cross-Spot Exchange Rates DM FF Yen DM .3050/51 1.3169/71 FF 3.2779/88 4.3365/84 Yen 75.9232/350 / 23.1595/618 aQuotes should be interpreted as units of the currency represented in the left-hand column per unit of currency shown in the top row. Quotes for the DM/yen and FF/yen are expressed in units per 100 yen. Exhibit 3 Eurocurrency Interest Rates 1 Month 3 Months 6 Months 12 Months Currency U.S. Dollar 5.6875-5.8125 5.5000-5.6250 5.5000-5.6250 5.6250-5.7500 Sterling 10.0625-10.1875 9.8750-9.9375 9.6875-9.7500 9.6250-9.7500 Deutsche mark 4.4375-4.5625 4.3125-4.4375 4.3125-4.4375 4.3125-4.4375 French Franc 7.1250-7.2500 7.1875-7.3125 7.1875-7.3125 7.2500-7.3750 Yen 5.1250-5.1875 4.7500-4.8125 4.6250-4.6875 4.6250-4.6875 SDR 5.9375-6.0625 5.8125-5.9375 5.7500-5.8750 5.8125-5.9375 Exhibit l Spot and Forward Exchange Rates Spot 1 Month 3 Months 6 Months 12 Months Currency Sterlinga 1.4890/00 55/52 160/156 302/289 560/523 Deutsche mark 2.0310/20 22/18 64/54 128/105 277/228 French Franc 6.6575/625 73/86 263/296 505/590 1194/1351 Yen 154.20/30 8/6 33/27 75/62 164/137 SDR 1.2141/43 5/3 12/8 18/11 24/12 au.S. dollars per unit of currency. Exhibit 2 Cross-Spot Exchange Rates DM FF Yen DM .3050/51 1.3169/71 FF 3.2779/88 4.3365/84 Yen 75.9232/350 / 23.1595/618 aQuotes should be interpreted as units of the currency represented in the left-hand column per unit of currency shown in the top row. Quotes for the DM/yen and FF/yen are expressed in units per 100 yen. Exhibit 3 Eurocurrency Interest Rates 1 Month 3 Months 6 Months 12 Months Currency U.S. Dollar 5.6875-5.8125 5.5000-5.6250 5.5000-5.6250 5.6250-5.7500 Sterling 10.0625-10.1875 9.8750-9.9375 9.6875-9.7500 9.6250-9.7500 Deutsche mark 4.4375-4.5625 4.3125-4.4375 4.3125-4.4375 4.3125-4.4375 French Franc 7.1250-7.2500 7.1875-7.3125 7.1875-7.3125 7.2500-7.3750 Yen 5.1250-5.1875 4.7500-4.8125 4.6250-4.6875 4.6250-4.6875 SDR 5.9375-6.0625 5.8125-5.9375 5.7500-5.8750 5.8125-5.9375

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