Applying IRP and IFE. Assume that Mexico has a one-year interest rate that is higher than the UK one- year interest rate. Assume that you believe in the international Fisher effect (IFE) and interest rate parity. Assume zero transactions costs.
Ed is based in the United Kingdom and attempts to speculate by purchasing Mexican pesos today, investing the pesos in a risk-free asset for a year, and then converting the pesos to pounds 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 pounds today and simultaneously selling pounds one-year forward, investing the pounds in a risk-free asset for a year, and then converting the pounds 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.