Covered interest arbitrage involves both
A)the purchase of a foreign asset and a forward contract in the market for foreign exchange.
B)the purchase of a domestic asset and a spot contract in the market for foreign exchange.
C)the sale of a foreign asset and the purchase of a forward contract in the market for foreign exchange.
D)the sale of domestic stocks and the purchase of foreign bonds.
E)None of the above.

Question

Quizplus · Accepted Answer

Covered interest arbitrage involves taking advantage of a discrepancy in interest rates between two countries by borrowing in a country with a lower interest rate and investing in a country with a higher interest rate. This is typically done by purchasing a foreign asset (such as a bond) and simultaneously entering into a forward contract in the market for foreign exchange, which locks in the exchange rate for the future delivery of the proceeds from the foreign asset back into the domestic currency. The difference between the interest earned on the foreign asset and the cost of borrowing in the domestic currency, plus the profit from the forward contract, should result in a riskless arbitrage opportunity.

Covered Interest Arbitrage Involves Both