1) If the current interest rate on 1 year T-notes is 0.194% and the projected inflation rate is 1.6%, what is the anticipated Real Interest Rate?

2) If the current interest rate on the 2 year Treasury Note is 0.28% and the rate on the 3 year T-Note is 0.36%, what is the implied 1 year rate going to be two years from now?

2 year Treasury Note = 0.28%

3 year Treasury Note = 0.36%

1 year implied rate 2 years from now = 0.52%

3) Currently 5 year T-notes provide a yield to maturity of 0.648% per year. At the same time, TIPS (Treasury Inflation Protected Securities) with a 5 year maturity provide a yield (before inflation) of -1.096% per year. What is the implied annual inflation rate over the next 5 years?

4) You will be receiving payment of NP 1 million from a client in Mexico one year from now. The current spot rate for the Peso is 1 NP = US$ 0.10. The current price of Peso futures is 1NP = US$ 0.102. Your expectation of the peso spot rate one year from now is:

Possible Outcome for

a) What would be your gain or loss from purchasing Pesos in the forward market under each of the 3 scenarios?

b) Given your estimated probabilities for each scenario, what would be your average gain or loss?

5. Assume the following information:

¨ British pound spot rate = $1.58

¨ British pound one-year forward rate = $1.58

¨ British one-year interest rate = 11%

¨ U.S. one-year interest rate = 9%

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a. Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 9% . What would be their net gain (per Dollar) from doing so?

b. If a large number of investors undertook this transaction, explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.

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