Earlier this morning, the annual U.S. interest rate was 6 percent and Mexico’s annual interest rate was 8 percent. The spot rate of the Mexican peso was $.16. The one-year forward rate of the peso was $.15. Assume that as covered interest arbitrage occurred this morning, the interest rates were not affected, and the spot rate was not affected, but the forward rate was affected, and consequently interest rate parity now exists. Explain which type of investor (Mexican or U.S.) engaged in covered interest arbitrage, whether they were buying or selling pesos forward, and how that affected the forward rate of the peso.
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