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. Show how you can realize a guaranteed profit from covered interest arbitrage. Assume that you are a euro-based investor. Also determine the size of the arbitrage profit.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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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. Show how you can realize a guaranteed profit from
covered interest arbitrage. Assume that you are a euro-based investor. Also determine the
size of the arbitrage profit.

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