Covered interest rate arbitrage with withholding tax. On September 1, 2013, the treasurer of Volvo, the Swedish automotive manufacturer, is faced with the following investment dilemma: he could invest the 500 million Swedish crowns

(SEK) that will be available for the next 60 days in the Swedish money market and earn a return of 6. 25 percent on an annual basis, or he could invest his funds in the euro (€) money market and earn a much lower return of 3. 75 percent.

a. Do you have sufficient information to reach a decision as to selecting the optimal investment opportunity? What are the additional pieces of information needed to reach a meaningful decision?

b. On September 1, 2013, the following information concerning the relationship between the Swedish crown and the euro (€) was made available: SEK 1 =

€7.84 on a spot basis; the € was at a 3. 00 percent premium (annual basis).

Where should the funds be invested?

c. Does the interest rate parity theory hold in the previous case? Why or why not?

d. How would a 10 percent withholding tax imposed by euro-zone governments on interest earnings accruing to nonresident foreign entities affect your decision in part b?

e. What is the maximum rate of withholding tax that would leave your decision to invest your funds in the euro money market unchanged?