Covered interest arbitrage can be taken advantage of when premiums in forward rates are not exactly equal to the interest rate differential between two countries.

Question

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Covered interest arbitrage involves borrowing money in a low-interest-rate country, converting it into the currency of a high-interest-rate country, and investing it in bonds in the high-interest-rate country. The goal is to take advantage of the interest rate differential between the two countries. However, the potential profit from this strategy is further enhanced when the forward exchange rate is different from the expected spot exchange rate. Therefore, if premiums in forward rates are not exactly equal to the interest rate differential between two countries, covered interest arbitrage can be taken advantage of.

Covered Interest Arbitrage Can Be Taken Advantage of When Premiums