Spot rate = 19 pesos/$

One year Forward Rate = 20 pesos/$

You have $1,000,000

Interest Rates:

One year Govt Debt	Rate
Mexico	7%
USA	1%

1. 1. Would you be better off converting your dollars to pesos (at the spot rate), holding pesos for one year, and converting the pesos back (at the forward rate) at the end of the year? Or would it be better to just keep your dollars in a US bank account for the year?
 
2. 2. What effects would people's attempts to take advantage of covered interest arbitrage opportunities have on the spot rate, the one-year forward rate, the interest rate in Mexico, and the interest rate in the US?
 
3. 3. What would the forward rate have to move to for this arbitrage opportunity to be eliminated if the spot rate and the US and Mexican interest rates remained the same?

Answer rating: 100% (QA)

To determine whether it is better to convert dollars to pesos and engage in covered interest arbitrage or keep dollars in a US bank account we need to ... View the full answer