Covered interest arbitrage from a U. S. dollar perspective when the euro futures price (expressed in $/€) is too high involves
A) buying foreign exchange futures contracts
B) selling interest rate futures contracts
C) lending funds in risk-free euro investment
D) selling euros
E) buying euro stock index ETFs

Question

Quizplus · Accepted Answer

Covered interest arbitrage involves borrowing in a currency with a lower interest rate and investing in a currency with a higher interest rate, while hedging the exchange rate risk. In this case, if the euro futures price in USD is too high, it means that the USD is overvalued compared to the EUR, which makes the EUR-denominated investments attractive. Thus, one can borrow USD at a lower interest rate, convert it into EUR, and invest in a risk-free euro-denominated investment that yields a higher return than the USD borrowing cost. By doing so, the investor earns a profit, which is the difference between the returns on the euro investment and on the USD borrowing cost. This strategy does not involve buying foreign exchange futures contracts, selling interest rate futures contracts, selling euros, or buying euro stock index ETFs.

Covered Interest Arbitrage from a U