Assume the following information: Spot rate today of Swiss franc
=
$)60
1-year forward rate as of today for Swiss franc
=
$)63
Expected spot rate 1 year from now
=
$)64
Rate on 1-year deposits denominated in Swiss francs
=
7%
Rate on 1-year deposits denominated in U.S. dollars
=
9%

From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____ percent.
A) 5.00
B) 12.35
C) 15.50
D) 14.13
E) 11.22

Question

Assume the following information: Spot rate today of Swiss franc
=
$)60
1-year forward rate as of today for Swiss franc
=
$)63
Expected spot rate 1 year from now
=
$)64
Rate on 1-year deposits denominated in Swiss francs
=
7%
Rate on 1-year deposits denominated in U.S. dollars
=
9%
​
From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____ percent.
A) 5.00
B) 12.35
C) 15.50
D) 14.13
E) 11.22

Quizplus · Accepted Answer

Covered interest arbitrage involves converting USD to CHF at the spot rate, investing in CHF, and converting back to USD at the forward rate. The return is calculated as:  1. Convert $1,000,000 to CHF at $0.60/CHF = 1,666,667 CHF.  2. Invest at 7% for 1 year = 1,666,667 * 1.07 = 1,783,334 CHF.  3. Convert back to USD at $0.63/CHF = 1,783,334 * 0.63 = $1,123,500.  4. Rate of return = ($1,123,500 - $1,000,000) / $1,000,000 = 12.35%.

Assume the Following Information: Spot Rate Today of Swiss Franc