Covered interest arbitrage

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Reference no: EM13727518

Covered Interest Arbitrage

Assume that the interest rates for both the U.S. and German banks are 2%. You borrow $1M dollars from a U.S. bank for 6 months, convert it to Euros and invest it in a German bank for 6 months. The spot rate is 1.3664 USD per EUR.

The forward rate is currently 1.3749 USD per EUR.

a) If interest rate parity holds, what should the German interest rate be?

b) Do you have an opportunity for covered interest arbitrage? Explain why or why not.

c) What is your profit in USD after 6 months on your $1M if you engage in covered interest arbitrage using a forward contract at the rate stated?

Reference no: EM13727518

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