Forces of Covered Interest Arbitrage As of now, the nominal interest rate is 6 percent in the United States and 6 percent in Australia. The spot rate of the Australian dollar is $0.58, whereas the one year forward rate of the Australian dollar exhibits a discount of 2 percent. Assume that as covered interest arbitrage occurred this morning, neither interest rates nor the spot rate of the Australian dollar was affected, but the forward rate of the Australian dollar was affected. Consequently, interest rate parity now exists. Explain the forces that caused the forward rate of the Australian dollar to change by completing this sentence: The_____ [Australian or U.S.] investors could benefit from engaging in covered interest arbitrage. their arbitrage would involve_____ [buying or selling] Australian dollars forward, which would cause the forward rate of the Australian dollar to_____[ increase or decrease].

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 7, Problem 53QA
Textbook Problem

Forces of Covered Interest Arbitrage As of now, the nominal interest rate is 6 percent in the United States and 6 percent in Australia. The spot rate of the Australian dollar is $0.58, whereas the one year forward rate of the Australian dollar exhibits a discount of 2 percent. Assume that as covered interest arbitrage occurred this morning, neither interest rates nor the spot rate of the Australian dollar was affected, but the forward rate of the Australian dollar was affected. Consequently, interest rate parity now exists. Explain the forces that caused the forward rate of the Australian dollar to change by completing this sentence: The_____ [Australian or U.S.] investors could benefit from engaging in covered interest arbitrage. their arbitrage would involve_____ [buying or selling] Australian dollars forward, which would cause the forward rate of the Australian dollar to_____[ increase or decrease].

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