Question

22. Assume the following information:

You have $2,000,000 (US dollars) to invest:
Current spot rate of euro = $1.30
1-year forward rate of euro = $1.25
1-year deposit rate in U.S. = 11%
1-year deposit rate in Europe = 14%

If you use covered interest arbitrage for a 1-year investment, what will be the amount of U.S. dollars you will have after one year? (Points : 3.5)

   -$2,192,307.69.
   -$2,371,200.00.
   -$3,672,500.00.
   -$1,403,076.92.

Question 23. 23. Continued from Question 22, does the cover interest arbitrage work for you as a U.S. investor? And does Interest Parity hold under the current market condition presented in Question 22? (Points : 3.5)

   -Yes, the covered interest arbitrage works for the U.S. investor because the yield is higher than 11% earned by investing in U.S. Thus, the interest rate parity does not hold.
   -No, the covered interest arbitrage does not work for the U.S. investor because the yield is lower than 11% earned by investing in U.S.. However, the interest rate parity does not hold, either.
   -No, the covered interest arbitrage does not work for the U.S. investor because the yield is lower than 11% earned by investing in U.S.. Thus, the interest rate parity does not hold, either.
   -Yes, the covered interest arbitrage works for the U.S. investor because the yield is higher than 11% earned by investing in U.S. However, the interest rate parity holds.

Answer 1

22)	The premium of (discount) on the Euro = 1.25/1.3-1 =	-3.85%
	Converting to euro and investing in euro will yield a maturity value of = (2000000/1.3)*1.14=	$     17,53,846.15
	Reconverting to $ after 1 year, will yield	$     21,92,307.69
23)	No, the covered interest arbitrage does not work for the U.S. investor because the yield is lower than 11% earned by investing in U.S.. Thus, the interest rate parity does not hold, either.