Explain and show all necessary backup calculations. 5) Interest rate parity exis

Question

Explain and show all necessary backup calculations. 5) Interest rate parity exists between the U.S. and Poland (its currency is the zloty). Assume that there is zero probability of any financial or political problem in either country such as a bank default or government restrictions on bank deposits or currencies. Melvin is from Poland and plans to invest in the U.S. What is Melvin's return if he invests in the U.S. and covers the risk of his investment with a forward contract (put your answer in the green box below)? Hint: There is no major math here and you have all the info you need. one-year risk-free CD (deposit) rate in the U.S 7.00% one-year risk-free CD rate in Poland (denominated in the zloty) 5.00% Hints and examples Homework+

Explanation / Answer

Melvin's return is 5%. Because he will earn 7% if he invests in the US, but will pay about 2%, when he buys forward contract in Poland to cover it's risk.

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