Please help with Q17 of the item set above. Having difficulty in understanding the solution to the same, please share the solution for the question.
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To enter into a carry trade we can borrow GBP at 2% and invest in AUD.
Our investment will have 2 types of returns- Return due to appreciation of AUD and return due to investment (at AUD LIBOR).
Let us first calculate the appreciation of AUD.
Initial GBP/AUD=1.04 x 0.6611 = 0.687544
Expected GBP/AUD after 1 year= 0.9956 x 0.7010 = 0.697916
So, Percentage appreciation = 0.697916/0.687544 – 1 = 0.015085 = 1.508%
Let us consider AUD LIBOR to be x
So, to earn a net return of 0,
Our return on investment should be equal to our repayment of borrowing
(1+x)(1.01508)=1.02
So if you equate, you get x as 0.0048= 0.48%
Option A.
Hope this helps!