Assume the U.S. interest rate is 2 percentage points higher than the Swiss rate, and the forward rate of the Swiss franc has a 4 percent premium. Given this information:
A) Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland.
B) U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
C) Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland AND U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
D) None of these are correct.

Question

Quizplus · Accepted Answer

With a 2 percentage point difference in interest rates and a 4 percent premium on the forward rate of the Swiss franc, U.S. investors earn a higher rate of return by attempting covered interest arbitrage, as they can borrow in the U.S. at a lower rate and invest in Switzerland at a higher rate, while also benefiting from the premium on the Swiss franc. Swiss investors would not earn a higher rate of return as they would have to borrow at a higher rate in Switzerland to invest in the U.S., offsetting any potential benefits from the premium on the Swiss franc.