The Question and Answers of Treasury Risk

Running head: TREASURY RISK
Treasury Risk
Name of the Student:
Name of the University:
Author Note:

TREASURY RISK1
Table of Contents
Answer to Question 1:................................................................................................................2
Part 1:.....................................................................................................................................2
Part 2:.....................................................................................................................................3
Part 3:.....................................................................................................................................4
Answer to Question 2:................................................................................................................4
Part a:.....................................................................................................................................4
Part b:.....................................................................................................................................5
Part c:.....................................................................................................................................6
Part d:.....................................................................................................................................6
References:.................................................................................................................................9

TREASURY RISK2
Answer to Question 1:
Part 1:
The interest rate parity condition means the forward rate less the spot rate should be
equal to the interest rate differential. If the condition is not met then the parity condition does
not hold good and arbitrage profit can be generate from the same.
Thus for example if the spot rate is $ 1 per pound while the forward rate is $ 1.0234
per pound, the difference among the spot rate and forward rate is given by,
=($ 1.1234-$ 1)/$ 1= 2% approx., while the interest rate for country A is 5% while the
interest rate of country B is 3%, then the interest rate differential among the two countries is
2%. Thus the interest rate parity holds good in such a scenario. However, if the difference
between the forward rate and the spot rate is not equal to 2%, then the interest rate parity does
not hold good and the investor can earn arbitrage profits. Thus the forward rate which should
be such that the interest rate parity holds good for the following is provided in the following
steps.
Thus as per the question, the spot rate and the forward rates have been provided with
the bid ask rate. The bid rate is the rate at which the investor can sell to the bank and the ask
rate is the rate at which the investor can purchase from the bank. Thus for simplicity of
calculating interest rate parity mid rates are taken for the same (Fritz and Mühlich 2019).
Mid Spot Rate = $ 1.2575 per pound
Mid Forward Rate = $ 1.2375 per pound
Forward discount Premium = (($ 1.2375-$ 1.2575)/$ 1.2575)*100 = 1.59%
Interest rate US 3% UK 5%,