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24 December, 09:52

Suppose that the annual rate of returns on dollar deposits equals 2% and the rate of return on euro deposits is 1%. Furthermore, assume that expected exchange rate in a year is $1.1=1 euro and the current exchange rate is $1.08=1 euro. Should you invest in dollar deposits or euro deposits?

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  1. 24 December, 11:36
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    I should invest in dollar deposits.

    Explanation:

    Current exchange rate is 1 euro = $1.08

    Assuming I have y euro, the equivalent in dollar is $1.08y

    Rate of return on dollar deposit = 2% = 0.02

    Return on investment = $1.08y + (0.02 * $1.08y) = $1.08y + $0.0216y = $1.1016y

    Rate of return on euro deposit = 1% = 0.01

    Return on investment = y euro + (0.01 * y euro) = y euro + 0.01 y euro = 1.01y euro = 1.01y * $1.08 = $1.0908y

    I should invest in dollar deposits because the return on investment is greater than euro deposits.
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