Suppose you have $1000 that serves as margin for $9000 one year loan where the interest rate is 1%. You invest the total = $10,000 in Europe where the exchange rate is $1.25 $/€. The one year interest rate in Europe is 4%.
a. According to the UIP, what is the expected exchange rate on year from now?
Scenario 1: The $/€ exchange rate remains constant over the holding period = 1 year Scenario 2: The exchange rate after one year is 1.3 $/€
b. Assuming scenario 1, what is your profit/loss and your rate of return in $ when you close your position?
c. Assuming scenario 2, what is your profit/loss and your rate of return in $ when you close your position?