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Covered interest arbitrage margin

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Reference no: EM131400868

The European Monetary Authority is considering issuing a new 3-month bond denominated in "Euros" which will pay a 3% annual interest rate. The current issue of 3-month Canada Savings Bonds pays 3.6% annually.

a) If the current exchange rate is 1.2 Canadian Dollars per Euro and the 3-month forward exchange rate is 1.25 Canadian Dollars per Euro, should a resident of Canada invest in the Canada Savings Bond or in the Euro-bond?

b) Assuming that the new Euro-bond is issued with a 3% annual interest rate, in which direction would you expect Canadian interest rates and the Canadian Dollar-Euro spot exchange rate to change?

c) Again, assuming that the new Euro-bond is issued with the 3% annual interest rate, what value for the Canadian interest rate would be consistent with a zero Covered Interest Arbitrage Margin?

Reference no: EM131400868

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