Suppose the U.S. dollar interest rate is 5% and the euro interest rate is 6%. Assume no
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Question:
Suppose the U.S. dollar interest rate is 5% and the euro interest rate is 6%. Assume no transaction costs, fees, or commissions. In all markets, the spot rate for euros is $1.25. You believe that in one year's time the spot rate for euros will be $1.30. An investor would like to invest $100,000 for one year and is willing to take on risk for a higher return.
I. How would you advise the investor?
II. What if you are incorrect and the euro rate is lower? Calculate the "break-even" exchange rate: that is, an investment that returns the same as investing $100,000 at 5%.
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