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Determine the arbitrage profit

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Problem: Currently, the spot exchange rate is $1.50/£ and the three-month forward exchange rate is $1.52/£. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or £1,000,000.

Required:

Question 1: Determine whether the interest rate parity is currently holding.

Question 2: If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit.

Question 3: Explain how the IRP will be restored as a result of covered arbitrage activities.

Reference no: EM132466244

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