Exhibit 7-1
Assume the following information:
You have $300,000 to invest:
The spot bid quote 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 United States is 6%
The 180-day interest rate in Europe is 8%
-Refer to Exhibit 7-1 above. If you conduct covered interest arbitrage, what is your percentage return aFter 180 days? Is covered interest arbitrage feasible in this situation?
A)7.96 percent; feasible
B)6.04 percent; feasible
C)6.04 percent; not feasible
D)4.07 percent; not feasible
E)10.00 percent; feasible

Question

Quizplus · Accepted Answer

Covered interest arbitrage involves converting dollars to euros at the spot rate, investing in Europe, and converting back at the forward rate. The return in euros is 8%, and converting back to dollars at the forward rate gives a return of 6.04%, which is feasible as it is higher than the US interest rate.

Exhibit 7-1 Assume the Following Information