Return Due to Covered Interest Arbitrage
Response to the following problem:
Interest rate parity exists between the United States and Poland (its currency is the zloty). The 1-year risk-free CD (deposit) rate in the United States is 7 percent. The 1-year risk-free CD rate in Poland is 5 percent and denominated in zloty.
Assume that there is zero probability of any financial or political problem such as a bank default or government restrictions on bank deposits or currencies in either country.
Myron is from Poland and plans to invest in the United States. What is Myron's return if he invests in the United States and covers the risk of his investment with a forward contract?