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14 June, 18:01

8. Today, the one-year U. S. interest rate is 2%, while the one-year interest rate in Mexico is 8%. The spot rate of the Mexico peso (MXP) is $.06 The one-year forward rate of the MXP exhibits a 10% discount. Determine the yield (percentage return on investment) to an investor from Mexico who engages in covered interest arbitrage.

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  1. 14 June, 20:20
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    Solution:

    Given,

    1 Year U. S. interest rate = 2%

    1 Year interest rate in Mexico = 8%

    Rate of the Mexico peso = $0.06

    MXP exhibits = 10% discount

    Now,

    The yield of an investor from Mexico who engages in protected interest arbitration (percentage return on investment):

    (F - 0.06) / 0.06 = - 10%

    F = $0.054 / MXP;

    MXP1 x.$0.06 / MXP (1+2%) / $0.054 = MXP 1.1333

    Yield of 13.33% > 8% in Mexico
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