Suppose you are an American investor who has 1,000 dollars. You have two different investment options:

Option 1. You can place your money in a bank in New York. Option 2. You can place your money in a bank in Paris .

The (one-year) interest rate on bank deposits is 4% in New York and 2% in the Paris.

The (one-year) forward dollar/euro exchange rate (F_$/e) is 0.9 dollar per euro

and the spot rate (E_$/e) is 0.85 dollar per euro. Answer the following ques- tions, using the exact equations for UIP and CIP as necessary. Show your work.

1. What is the return on Option 1 (dollar deposit) for the investor?

1. What is the return on Option 2 (euro deposit) in which investor uses a Forward Contract?

1. Is there an arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market?

1. If the spot rate (E_$/e) is 0.85 dollar per euro (as given in the question), and interest rates are as stated previously, what is the forward rate, according to covered interest parity (CIP)?