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Question - Emily Griffin is a foreign exchange trader with Barclays who has access to $2,000,000 US or the UK pound (GBP) equivalent. She notices the following US dollar (USD) and UK pound (GBP) foreign exchange and interest rate quotes:

Spot exchange rate : USD 1.2490 /GBP

Six months forward exchange rate : USD 1.2535 /GBP

Expected spot exchange rate in six months : USD 1.2610 /GBP

Six months $ interest rate : 2.2% per year

Six months GBP interest rate : 1.4% per year

Required -

(a) In the context of interest rate parity, under what conditions would an interest rate arbitrage be possible?

(b) Show the steps Emily would need to take to realise an uncovered interest rate arbitrage profit and calculate the profit?

(c) Discuss how a covered interest arbitrage strategy is different to an uncovered interest arbitrage strategy?

Reference no: EM133020609

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