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 1year deposits denominated in Swiss francs = 7%
Rate on 1year 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 ______%.

Question

Quizplus · Accepted Answer

Covered interest arbitrage involves converting USD to CHF at the spot rate, investing in CHF at 7%, and converting back to USD at the forward rate. The return is calculated as follows:  1. Convert $1,000,000 to CHF at the spot rate: $1,000,000 / 0.60 = CHF 1,666,667  2. Invest CHF 1,666,667 at 7% for 1 year: CHF 1,666,667 * 1.07 = CHF 1,783,334  3. Convert CHF 1,783,334 back to USD at the forward rate: CHF 1,783,334 * 0.63 = $1,123,500  4. Calculate the rate of return: ($1,123,500 - $1,000,000) / $1,000,000 = 0.1235 or 12.35%

Assume the Following Information