Suppose that the six-month interest rate in the United States is 6%, while the six-month interest rate in Mexico is 8%. Further, assume the spot rate of the peso is $0.20. Suppose that you have $500,000 with which to attempt covered interest arbitrage. Assume the forward rate is $0.19630, as you just calculated, and the interest rates are the same as have been used throughout this problem. To start, you exchange your $500,000 (at the spot rate of $0.20) for 2,500,000peso. After depositing these funds for 6 months, and earning a return of 8%, your deposit grows to 2,700,000peso. When you convert your 2,700,000peso back to dollars, you end up with approximately over your original $500,000. However, had you simply deposited your $500,000 in an account and accrued 6% interest, you would have This ex illustrates that covered interest arbitrage domestic account under interest rate parity. for a profit of about , for a profit of offer a significantly larger return than simply depositing the funds in a
Suppose that the six-month interest rate in the United States is 6%, while the six-month interest rate in Mexico is 8%. Further, assume the spot rate of the peso is $0.20. Suppose that you have $500,000 with which to attempt covered interest arbitrage. Assume the forward rate is $0.19630, as you just calculated, and the interest rates are the same as have been used throughout this problem. To start, you exchange your $500,000 (at the spot rate of $0.20) for 2,500,000peso. After depositing these funds for 6 months, and earning a return of 8%, your deposit grows to 2,700,000peso. When you convert your 2,700,000peso back to dollars, you end up with approximately over your original $500,000. However, had you simply deposited your $500,000 in an account and accrued 6% interest, you would have This ex illustrates that covered interest arbitrage domestic account under interest rate parity. for a profit of about , for a profit of offer a significantly larger return than simply depositing the funds in a
Principles of Economics 2e
2nd Edition
ISBN:9781947172364
Author:Steven A. Greenlaw; David Shapiro
Publisher:Steven A. Greenlaw; David Shapiro
Chapter29: Exchange Rates And International Capital Flows
Section: Chapter Questions
Problem 17RQ: Does a higher inflation rate in an economy, other things being equal, affect the exchange rate of...
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![Suppose that the six-month interest rate in the United States is 6%, while the six-month interest rate in Mexico is 8%. Further, assume the spot rate
of the peso is $0.20.
Suppose that you have $500,000 with which to attempt covered interest arbitrage. Assume the forward rate is $0.19630, as you just calculated, and
the interest rates are the same as have been used throughout this problem.
To start, you exchange your $500,000 (at the spot rate of $0.20) for 2,500,000peso. After depositing these funds for 6 months, and earning a return
of 8%, your deposit grows to 2,700,000peso.
When you convert your 2,700,000peso back to dollars, you end up with approximately
over your original $500,000.
However, had you simply deposited your $500,000 in an account and accrued 6% interest, you would have
This example illustrates that covered interest arbitrage
domestic account under interest rate parity.
for a profit of about
▼, for a profit of
offer a significantly larger return than simply depositing the funds in a](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fbb5aba3c-4931-42d1-80b4-3d9f41ab8cf8%2F3447f1ec-54fd-4eb2-a53f-f4503ae68107%2F92dz7z7d_processed.jpeg&w=3840&q=75)
Transcribed Image Text:Suppose that the six-month interest rate in the United States is 6%, while the six-month interest rate in Mexico is 8%. Further, assume the spot rate
of the peso is $0.20.
Suppose that you have $500,000 with which to attempt covered interest arbitrage. Assume the forward rate is $0.19630, as you just calculated, and
the interest rates are the same as have been used throughout this problem.
To start, you exchange your $500,000 (at the spot rate of $0.20) for 2,500,000peso. After depositing these funds for 6 months, and earning a return
of 8%, your deposit grows to 2,700,000peso.
When you convert your 2,700,000peso back to dollars, you end up with approximately
over your original $500,000.
However, had you simply deposited your $500,000 in an account and accrued 6% interest, you would have
This example illustrates that covered interest arbitrage
domestic account under interest rate parity.
for a profit of about
▼, for a profit of
offer a significantly larger return than simply depositing the funds in a
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