Answer:
Spot USD/GBP rate = 1.5711
(a) 1 year USD/GBP forward rate:
= [Spot rate × (1 + Domestic currency interest rate)] ÷ (1 + foreign currency interest rate)
= [1.5711 × (1+0.19%)] ÷ (1 + 0.39%)
= 1.56797, which means the USD will be at a forward premium
b) The observed 1 year forward rate is 1.60 which differs from the ideal forward rate.
This means an arbitrage opportunity exists here.
c) I would sell GBP forward for 1 year @ 1.60.
This means that I will receive USD 1.60 for every 1 GBP I sell instead of 1.56797 that is the ideal deal.
This is how I would take advantage of the arbitrage opportunity.
