Question

Here are some prices in the international money markets:
Spot rate = $1.46 : €
Forward rate (one year) = $1.49 : €
Interest rate (€) = 7% per year
Interest rate ($) = 9% per year
a. Assuming no transaction costs or taxes exist, do covered
arbitrage profits exist in this situation? Describe
the flows.
b. Suppose now that transaction costs in the foreign
exchange market equal 0.25% per transaction. Do
unexploited covered arbitrage profit opportunities
still exist?
c. Suppose no transaction costs exist. Let the capital
gains tax on currency profits equal 25% and the ordinary
income tax on interest income equal 50%. In this
situation, do covered arbitrage profits exist? How large
are they? Describe the transactions required to exploit
these profits.

Answer 1

According my calculations in both currency investment the return from investing in Europe is nevertheless greater than the return from investing in the US.

Plz see calculation details in attachedto