Suppose the U.S. dollar interest rate is 5% and the euro interest rate is 6%. Assume no transaction costs, fees, or commissions. In all markets, the spot rate for euros is $1.25. You believe in one year's time the spot rate for euros will be $1.30. An investor would like to invest $100,000 for one year and is willing to take on risk for a higher return.
A. How would you advise her?
B. What if you are incorrect and the euro rate is lower? Calculate the “break-even” exchange rate; that is, an investment that returns the same as investing $100,000 at 5%.