Beth Miller does not believe that the international Fisher effect (IFE) holds. Current 1-year interest rates in Europe are 5 percent, while 1-year interest rates in the United States are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10.
a. According to the IFE, what should the spot rate of the euro in 1 year be?
b. If the spot rate of the euro in 1 year is $1.00, what is Beth’s percentage return from her strategy?
c. If the spot rate of the euro in 1 year is $1.08, what is Beth’s percentage return from her strategy?
d. What must the spot rate of the euro be in 1 year for Beth’s strategy to be successful?
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