Problem 7 (Currency Risk) Betty and Bob are interested in investing in the Freedonia Stock Market which requires investments to be purchased or sold...

Problem 7 (Currency Risk) Betty and Bob are interested in investing in the Freedonia Stock Market which requires investments to be purchased or sold in Freedonia dollars ($F). Hence there is a currency risk in addition to the stock market risk.

           Currently one year interest rates are 5% per annum continuous in the U.S and 12% per annum continuous in Freedonia. Currently the currency markets are such that you can buy $F 3 per $1, U.S. This is the spot price, 3.

           a Compute the forward price of a 1 year forward contract. See Section 27 in your text for the relevant discussion. Be careful to be consistent in how you price one currency in terms of another.

           b Bob has an account with $1000 (U.S.). He converts to $F and makes 15% continuous in one year in the Freedonia Stock Market. After this one year the currency price is now 4 that is $F 4 per $1 U.S. He converts back to U.S dollars at the rate of exchange. What amount (in U.S dollars) did he make or lose in the one year? What was his continuous rate of return?

           c Betty does exactly the same except that in the beginning she sells a one year forward contract with forward price computed in part a. She makes 15% continuous in one year and converts back (all of the money) using the forward contract. What amount (in U.S. dollars) did she make or lose in the one year? What was her continuous rate of return?