Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the forward exchange rate, with one-year maturity, is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000 or €892,857 (which is the equivalent of $1,000,000 at the spot exchange rate of $1.12/€).
-Covered interest arbitrage would not be possible if the forward rate would be:
A) $1.1093/€.
B) $1.1248/€.
C) $1.1362/€.
D) $1.1611/€.

Question

Quizplus · Accepted Answer

To determine the neutral exchange rate, the amount of €924,107 matured from investment in Germany must be adjusted to the amount borrowed in dollars plus interest. That is,Let X be the forward rate. So,€924,107 × $X/€ = $1,050,000X = $1,050,000/€924,107 = $1.1362/€

Suppose That the Annual Interest Rate Is 5