Answer to Question #157613 in Economics for Nisha chaudhary

Question

If the positive interest rate differential in favor of a foreign monetary center is 7 percent

per year and the foreign currency is at a forward premium of 3 percent per year, roughly

how much would an interest arbitrageur earn from the purchase of foreign three-month

treasury bills if he or she covered the foreign exchange risk?

Answer 1

Forward premium is the amount by which the current forward rate exceeds the spot rate.

$$\frac {1}{4}(7-3)=1$$

Since the deal is designed for three months, that is, for one-fourth of the year, he received 1%.