Question

Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange

Answer 1

Answer:

The interest rate for the euro zone to avoid arbitrage has to be C) 8.62%

Explanation:

Hi, we need to solve for r(eur) the following equation in order to find an interest rate that will avoid arbitrage.

$Forward=Spot(\frac{1+r(usd)}{1+r(eur)} )$

That is:

$1.16 =1.20 (\frac{1+0.05} {1+r(eur)} )$

$(1+r(eur)) =\frac{1.20} {1.16} (1+0.05)$

$r(eur)=\frac{1.20}{1.16}(1+0.05)-1$

$r(eur)=0.0862$

So, the euro zone rate to avoid arbitrage is 8.62%, which is option C)

Best of luck.