Assume the following information:
You have $300,000 to invest
The spot bid rate for the euro (€)is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid)of the euro is $1.08
The 180-day forward rate (ask)of the euro is $1.10
The 180-day interest rate in the U.S.is 6%
The 180-day interest rate in Europe is 8%
If you conduct covered interest arbitrage,what amount will you have after 180 days
A) $318,109.10.
B) $330,000.00.
C) $312,218.20.
D) $323,888.90.
E) none of the above

Question

Quizplus · Accepted Answer

Under covered interest arbitrage, we borrow 300,000 dollars for 180 days at an interest rate of 6%. Therefore, we need to pay back 300,000 * (1+0.06/2) = $318,000 after 180 days. We convert this amount into euros using the spot ask quote of $1.10 per euro, which gives us 318,000/1.10 = €289,090.91.
 
We invest this amount at the 180-day forward rate (bid) of $1.08. After 180 days, we receive €289,090.91 * 1.08 = $312,218.20. If we convert this back into dollars using the spot bid rate of $1.08 per euro, we get $312,218.20/1.08 = $289,109.10.

Finally, we repay the loan of $318,000 and keep the profit of $318,109.10 - $300,000 = $18,109.10.

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