C. Interest Arbitrage

U.S.

i=8%

France

i=8%

Exchange Rate

5 francs/$

One year

from now:

360-day Forward

exchange rate

4.8 francs/$

Now:

borrow $100,000

500,000 francs

540,000 francs

=500,000(1.08)

$112,500

$108,000

profit = $4,500

US credit market

French credit market

4.8

forward market

spot market

In equilibrium, the spot exchange rate will still be above the forward exchange rate (the difference will be less, but there still will be a difference).

Also in equilibrium, the interest rate in the United States will be higher than the interest rate in France.

In equilibrium, the spot exchange rate will still be above the forward exchange rate (the difference will be less, but there still will be a difference).