1. Suppose the 5-year interest rate on a dollar- denominated pure discount bond is 4.5% p.a. and the interest rate on a similar pure discount euro-denominated bond is 7.5% p.a. If the current spot rate is $1.08> :, what forward exchange rate prevents covered interest arbitrage?
2. Carla Heinz is a portfolio manager for Deutsche Bank. She is considering two alternative invest- ments of EUR10,000,000: 180-day euro deposits or 180-day Swiss franc (CHF) deposits. She has decided not to bear transaction foreign exchange risk. Suppose she has the following data: 180- day CHF interest rate of 8% p.a.; 180-day EUR interest rate of 10% p.a.; spot rate of EUR1.1960 > CHF; and 180-day forward rate of EUR1.2024> CHF. Which of these deposits provides the higher euro return in 180 days? If these were actually market prices, what would you expect to happen?