Assume that the U.S. interest rate is 5%, the European interest rate is 2%, and the future expected exchange rate in one year is $1.224. If the spot rate is $1.24, then the expected dollar return on euro deposits is:
A) 4%.
B) 7.1%.
C) 0.71%.
D) 0.129%.

Question

Quizplus · Accepted Answer

The expected dollar return on euro deposits is calculated by adjusting the European interest rate for the expected change in the exchange rate. The formula is: (1 + European interest rate) * (expected future exchange rate / current spot rate) - 1. Substituting the given values: (1 + 0.02) * (1.224 / 1.24) - 1 = 0.0071 or 0.71%.

Assume That the U