Investment in Italy and France

While investing or holding assets in other countries there are many factors, which should be considered. The countries risk a major concern for an investor. In Europe, almost all countries have political stability. Currency exchange rate is a crucial factor investment decision. Rosos intends to invest his large pension funds either in the domestic market or in Italy and France. To take the decision he ought to consider the interest rate and currency exchange rate. Germany keeps its currency under control by maintaining the inflation rate. To keep pace with the Deutschmark France and Italy increased interest rate. It would be a wise choice for Rosos to invest in those countries if the interest is higher. The unemployment rate should be considered because higher interest rate will not sustain for a long time with the higher unemployment rate. Italy has higher unemployment rate (11.3%) than France (10.4%).

Covered interest policy stipulates that forward interest premium or discount for one currency relative to other currency equals to the ratio of nominal interest rates on equal risk securities denominated in two currencies. Floating exchange rate implies that due to the depreciation of foreign currency can damage the return earned in foreign currency. Covered interest rate can be calculated by:

F= S* (1+Rd/1+Rf)

Where

F= Forward currency exchange rate

S= Current Exchange rate.

Rf = Foreign investment goods

Rd= Domestic investment Goods

DM to Franc exchange rate is .98, and DM to lira exchange rate is 1.12. There is a possibility of covered interest arbitrage is interest rate parity does not exist. If investment asset of Italy gives higher interest rate Rosos will convert DM to Lira and invest in Italy’s investment bond and purchase a forward on exchange rate at 1.12. For example, Italian investment bond gives 7% where German bond provides 5%. The exchange rate should be (1.07/1.05)×1.12= 1.14. Profit would be 100000×1.14-100000×1.12= 20000 DM. If transaction, brokerage costs, and taxes are ignored, Rosos can have higher return from the higher interest earned from the investment.