Answer:
The interest rate for the euro zone to avoid arbitrage has to be C) 8.62%
Explanation:
Hi, we need to solve for r(eur) the following equation in order to find an interest rate that will avoid arbitrage.
[tex]Forward=Spot(\frac{1+r(usd)}{1+r(eur)} )[/tex]
That is:
[tex]1.16 =1.20 (\frac{1+0.05} {1+r(eur)} )[/tex]
[tex](1+r(eur)) =\frac{1.20} {1.16} (1+0.05)[/tex]
[tex]r(eur)=\frac{1.20}{1.16}(1+0.05)-1[/tex]
[tex]r(eur)=0.0862[/tex]
So, the euro zone rate to avoid arbitrage is 8.62%, which is option C)
Best of luck.
