Assume the U.S. interest rate is 2 percentage points higher than the Swiss rate, and the forward rate of the Swiss franc has a 4 percent premium. Given this information:
A)Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland.
B)U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
C)A and B
D)none of the above

Question

Assume the U.S. interest rate is 2 percentage points higher than the Swiss rate, and the forward rate of the Swiss franc has a 4 percent premium. Given this information:​
A)Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland.
B)U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
C)A and B
D)none of the above

Quizplus · Accepted Answer

If the U.S. interest rate is higher than the Swiss rate, U.S. investors who attempt covered interest arbitrage can earn a higher rate of return by borrowing in the U.S. and investing in Switzerland. Additionally, the forward rate of the Swiss franc having a 4 percent premium means that investors can purchase Swiss francs today and receive a premium when exchanging them back to U.S. dollars in the future. Therefore, U.S. investors who attempt covered interest arbitrage can earn a higher rate of return than if they invested in the United States. Swiss investors who attempt covered interest arbitrage, on the other hand, would not earn any additional return beyond what they would receive by investing in Switzerland, given that they already have access to the Swiss interest rate.