Today, short-term interest rates in Australia are 8.50% and the corresponding U.S. rate is 6.0%. The current discount on forward Australian dollars is 2.0%. Can a U.S. trader use covered interest arbitrage to take advantage of this situation? If so what is the net effect?

Question

Quizplus · Accepted Answer

Solution:
Sell dollars, buy Australian dollars and invest in Australian securities at 8.5%. Sell Australian dollars forward at 2% discount. Trader earns 8.5% - 2% = 6.5% compared to 6% U.S. rate.

Today, Short-Term Interest Rates in Australia Are 8