Assume the following information:
U.S. investors have $1,000,000 to invest:
Given this information:
1-year deposit rate offered by U.S. banks=12%
1-year deposit rate offered on Swiss francs=10%
1-year forward rate of Swiss francs=$.62
Spot rate of Swiss franc=$.60

Question

Assume the following information:​
U.S. investors have $1,000,000 to invest:
Given this information:
1-year deposit rate offered by U.S. banks=12%
1-year deposit rate offered on Swiss francs=10%
1-year forward rate of Swiss francs=$.62
Spot rate of Swiss franc=$.60

Quizplus · Accepted Answer

Interest rate parity (IRP) exists when the difference in interest rates between two countries is equal to the difference between the forward exchange rate and the spot exchange rate. In this case, IRP does not exist because the yield from covered interest arbitrage (CIA) by investing in Swiss francs and then converting back to dollars at the forward rate provides a higher return than the domestic interest rate. Here's a brief calculation to illustrate:1. Convert $1,000,000 to Swiss francs at the spot rate of $0.60: $1,000,000 / $0.60 = 1,666,666.67 Swiss francs.2. Invest at the Swiss interest rate of 10% for one year: 1,666,666.67 * 1.10 = 1,833,333.34 Swiss francs.3. Convert back to dollars at the forward rate of $0.62: 1,833,333.34 * $0.62 = $1,136,666.67.Comparing the final amount to the amount obtained if invested domestically at 12%: $1,000,000 * 1.12 = $1,120,000.The yield from investing in Swiss francs and converting back at the forward rate is higher than investing domestically, indicating that IRP does not exist and that CIA results in a higher yield.

Assume the Following Information:​

Assume the Following Information: