Question

Assume the following information: Current spot rate of New Zealand dollar $.6686 Forecasted spot rate of New Zealand dollar 1 year from now $.7012 One-year forward rate of the New Zealand dollar $.6849 Annual interest rate on New Zealand dollars 5% Annual interest rate on U.S. dollars 6% Compute the return from covered interest arbitrage by a U.S. investor with $1000 to invest.

A)8.58%
B)5.00%
C)7.55%
D)2.55 %
E)6.00%

Answer 1

The return from covered interest arbitrage can be calculated by taking advantage of the interest rate differential between the two currencies. For a U.S. investor with $1000 to invest, the return is 7.55%.

Step-by-step explanation:

The return from covered interest arbitrage by a U.S. investor with $1000 to invest can be calculated by taking advantage of the interest rate differential between the two currencies. Here's how to calculate it:

1. Calculate the amount of New Zealand dollars you can buy with $1000 at the spot rate: $1000 / $0.6686 = NZD 1495.91
2. Invest the NZD 1495.91 in New Zealand at the interest rate of 5% for one year: NZD 1495.91 * (1 + 0.05) = NZD 1570.71
3. Convert the NZD back to USD at the forward rate: NZD 1570.71 * $0.6849 = $1075.55
4. Calculate the return: ($1075.55 - $1000) / $1000 * 100% = 7.55%

Therefore, the return from covered interest arbitrage for a U.S. investor with $1000 to invest is 7.55%, which corresponds to option C in the given choices.