Assume the current spot rate is C$1.0875 and the one-year forward rate is C$1.0724. Also assume the nominal risk-free rate in Canada is 3.9 percent while it is 4.1 percent in the U.S. How much additional income can you earn by using covered interest arbitrage as compared to investing $1 in the U.S for one year?

Question

Quizplus · Accepted Answer

Covered interest arbitrage involves converting USD to CAD at the spot rate, investing in Canada at the Canadian risk-free rate, and converting back to USD at the forward rate. The difference in returns compared to investing in the U.S. risk-free rate gives the additional income. Calculating this, the additional income is approximately $0.0126.

Assume the Current Spot Rate Is C$1