The Swiss one-year interest rate is 7 percent, while the U.S. one-year interest rate is 2 percent. Assume that interest rate parity exists. If a U.S. firm invests in a Swiss one-year deposit and sells Swiss francs forward with a forward contract to hedge its exchange rate exposure, the effective yield from investing in a one-year deposit in Switzerland will be about:

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Interest rate parity implies that the difference in interest rates between two countries is equal to the difference between the forward exchange rate and the spot exchange rate, expressed as a percentage of the spot exchange rate. This means that any gain from the higher interest rate in Switzerland (7%) would be offset by a loss in the currency exchange rate, resulting in an effective yield equal to the domestic interest rate of 2%.

The Swiss One-Year Interest Rate Is 7 Percent, While the U.S