The Mexican one-year interest rate is 9 percent, while the U.S. one-year interest rate is 3 percent. Assume that interest rate parity exists. If a U.S. firm uses the forward rate to forecast the exchange rate of the peso in one year, the expected effective yield from investing in a one-year deposit in Mexico is:

Question

The Mexican one-year interest rate is 9 percent, while the U.S. one-year interest rate is 3 percent. Assume that interest rate parity exists. If a U.S. firm uses the forward rate to forecast the exchange rate of the peso in one year, the expected effective yield from investing in a one-year deposit in Mexico is:​

Quizplus · Accepted Answer

Interest rate parity implies that the difference in interest rates between two countries is equal to the expected change in exchange rates between the countries' currencies. Therefore, if a U.S. firm invests in Mexico, the higher Mexican interest rate (9%) is offset by the expected depreciation of the peso against the dollar, resulting in an effective yield equal to the domestic interest rate of 3%.

The Mexican One-Year Interest Rate Is 9 Percent, While the U.S