Bonus Question: Covered Interest Arbitrage. Assume the following information: Qu
ID: 2775406 • Letter: B
Question
Bonus Question: Covered Interest Arbitrage. Assume the following information: Quoted Price Spot rate of Canadian dollar $.80 90-day forward rate of Canadian dollar $.79 90-day Canadian interest rate 4% 90-day U.S. interest rate 2.5% 1- Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1,000,000.) 2- What market forces would occur to eliminate any further possibilities of covered interest arbitrage?
Explanation / Answer
Answer:
(1+home currency interest rate)/(1+ foreign) = Forward rate / spot rate
(1+.04*3/12/ 1+.025*3/12) = 79/80
1.01/1.00625 = 79/80