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Assume that Mexico has a one - year interest rate that is higher than the U . S . one - year interest rate. Assume
Assume that Mexico has a oneyear interest rate that is higher than the US oneyear interest rate. Assume that you believe in the international Fisher effect IFE and interest rate parity. Assume zero transaction costs.
Ed is based in the United States and attempts to speculate by purchasing Mexican pesos today, investing the pesos in a riskfree asset for a year, and then converting the pesos to dollars at the end of one year.
Ed did not cover his position in the forward market. Maria is based in Mexico and attempts covered interest arbitrage by purchasing dollars today and simultaneously selling dollars one year forward, investing the dollars in a riskfree asset for a year, and then converting the dollars back to pesos at the end of one year.
Do you think the rate of return on Ed's investment will be higher than, lower than, or the same as the rate of return on Maria's investment? Explain.
The rate of return on Ed's investment will be
higher than
the rate of return on Maria's investment. Since interest rate parity exists, she will earn whatever the local riskfree interest rate is in
Select
Ed's expected rate of return is whatever the riskfree rate is in
Select
based on the IFE
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