Suppose the interest rate on one-year U.S. T-bills is 4% and interest rate on one-year British T-bills is 6.5%. If the dollar is at a forward premium against the British pound of 1%, an American investor who does not want to face exchange-rate risk (but does want to earn the highest possible return) should:

Question

Quizplus · Accepted Answer

Given the interest rates and the forward premium, investing in pound-denominated assets would yield a higher return even after accounting for the forward premium to hedge against exchange-rate risk. The higher interest rate in British T-bills (6.5%) compared to U.S. T-bills (4%), even after adjusting for the 1% forward premium, makes the British investment more attractive for an investor seeking the highest possible return without facing exchange-rate risk.

Suppose the Interest Rate on One-Year U