Which One of the Following Formulas Illustrates the Mechanics of Covered

question 75

Multiple Choice

Which one of the following formulas illustrates the mechanics of covered interest arbitrage? Assume the $1 is borrowed and S₀ = spot rate; F₁ = one-year forward rate; R_F = foreign country risk-free rate; and R_US = U.S.risk-free rate.

• A)$1 × F₁ × (1 + R_F)/S₀ - $1 × (1 + R_US)
• B)$1 × S₀ × (1 + R_F)/F₁ - $1 × (1 + R_US)
• C)$1 × F₁ × (1 + R_F)/S₀ + $1 × (1 + R_US)
• D)$1 × S₀ × (1 + R_F) - $1 × (1 + R_US)/F₁
• E)$1 × S₀ × (1 + R_F)/F₁ + $1 × (1 + R_US)

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Definitions:

IRRs

The Internal Rate of Return is a financial measurement utilized to assess the projected profitability of future investments.

After-Tax Cost

After-Tax Cost is the expense associated with a transaction or activity, taking into account the effect of income tax deductions or liabilities.

Tax Rate

The percentage at which an individual or corporation is taxed, which can vary according to income or profit levels.

Cost of Debt

The cost of debt is the effective rate that a company pays on its total debt, used in capital structuring decisions to evaluate the affordability of borrowing.