Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

A) Does interest arbitrage hold? Is covered interest arbitrage possible?

B) Suppose a typical US investor can borrow $1 million, and a typical Mexican investor can borrow 1 million pesos for arbitrage transactions. If an arbitrage opportunity is possible, decide which investor it favors, and the amount of arbitrage profits that can be gained.