Question

Assume that the U.S. one-year interest rate is 5 percent and the one-year interest rate on euros is 7 percent. You have $100,000 to invest and you believe that the international Fisher effect (IFE) holds. The euro's spot exchange rate is $1.20. What will be the yield on your investment if you invest in euros (please use 4 decimal points)? *Since you believe that IFE holds, you can find the forward rate (or the spot rate in the future) based on the IFE equation.

a. 3.5%

b. 4%

c. 5%

d. 2

Answer #1

1] | Forward rate per IFE = 1.20*1.05/1.07 = | 1.1776 |

2] | Amount to be invested in euros = 100000/1.2 = | € 83,333.3333 |

3] | Amount in euros after 1 year = 83333.33*1.07 = | € 89,166.6631 |

4] | Amount in $ after conversion at forward rate per IFE = 89166.6631*1.1776 = | € 1,05,002.6625 |

5] | Yield = 105002.6625/100000-1 = | 5.00% |

Answer: [c]
5.00% |

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