(A)If the Positive Interest Rate Differential in Favor of a Foreign

question 7

Essay

(a)If the positive interest rate differential in favor of a foreign monetary center is 3 percent per year and the foreign currency is at a forward discount of 1 percent per year,roughly how much would an interest arbitrageur earn from the purchase of foreign three-month treasury bills if he covers the foreign exchange risk?
(b)How much would an interest arbitrageur earn if the foreign currency were instead at a forward premium of 1 percent per year?
(c)What would happen if the foreign currency were at a forward discount of 3 percent per year?

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Definitions:

Differential Cost

Represents the difference in total cost that will arise from choosing one option over another in business decisions, often used in the evaluation of alternative projects or decisions.

Product P

A placeholder name for a specific product, often used in examples or theoretical scenarios.

Opportunity Cost

The amount of income forgone from an alternative to a proposed use of cash or its equivalent.

Differential Revenue

The difference in revenue between two alternative decisions or courses of action.