Question

A European investor can earn a 4.75 percent annual interest rate in Europe or 2.75 percent per year in the United States. If the spot exchange rate is $1.58 per euro, at what one-year forward rate would an investor be indifferent between the U.S. and European investments?

Answer 1

Answer:

To obtain the same returns, the interest rate in the United States should be 7.5%.

Explanation:

Since $ 1.58 dollars is equal to $ 1 euro, the difference between both currencies arises from the following calculation:

1 = 100

1.58 = X

((1.58 x 100) / 1) = X

158/1 = X

158 = X

Therefore, a euro is worth 58% more than a dollar is worth.

Thus, if the investment in Europe has an interest rate of 4.75%, to obtain the same return in dollars, an interest rate of 58% must be obtained, that is:

4.75 x 1.58 = X

7.5 = X

Thus, to obtain the same returns, the interest rate in dollars should be 7.5%.