QUESTION 3

a) The annual interest rate in Brazil is 8 percent. The annual U.S. interest rate is 12

percent. The spot rate of the Brazilian real is $ 0.19. The forward rate of the Brazilian real

is $0.23.

i) Calculate whether Interest Rate Parity holds?.

[1 mark]

ii) Is covered interest arbitrage feasible for US Investors assuming that the initial

investment of $500,000? If yes, calculate the yield from the arbitrage.

[2 marks]

iii) Is covered interest arbitrage feasible for Brazil investors assuming that the initial

investment is BRL 500,000? If yes, calculate the yield from the arbitrage.

*In each case ((ii) and (iii)) explain why covered interest arbitrage is or is not feasible.

[2 marks]

b) In the past few decades, Chinese government took the initiative to do the direct intervention. The

Chinese have often followed a policy of keeping the Chinese currency (Renminbi) undervalued.

Explain why and how the Chinese intervene and how this intervention affects the US?