Jennifer is considering a covered interest arbitrage investment in UK pounds. The current exchange rate is £0.50/$ and the six-month forward rate is £0.49/$. If the annual rate on riskless securities in the US is 3% then Jennifer will make a greater profit via CIA compared to the US investment.

Question

Quizplus · Accepted Answer

Covered interest arbitrage (CIA) involves exploiting the difference between interest rates and forward exchange rates. If the forward rate is less favorable than the spot rate, as in this case (£0.49/$ forward vs. £0.50/$ spot), the potential profit from CIA may not exceed the US riskless rate of 3% annually.

Jennifer Is Considering a Covered Interest Arbitrage Investment in UK