Reference no: EM132799565
Suppose that the current spot exchange rate is €1.50/£ and the one-year forward exchange rate is €1.60/£. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, i.e., £666,667, at the current spot exchange rate.
Assume that you are a euro-based investor. Show how you can realize a guaranteed profit from covered interest arbitrage and determine the size of the arbitrage profit by answering the following questions:
a. Does IRP hold?
(Answer 1 for Yes; Answer 2 for No)
b. Which currency should you borrow money from?
(Answer 1 for €; Answer 2 for £).
c. What will be your total debt in one year?
(Answer with just the number. No comma or symbols).
d. After using the borrowed money and make an investment in another market, how much is your arbitrage profit?
(Answer with just the number. No comma or symbols).
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