There can be an opportunity for covered interest arbitrage if:
A) the interest rate is low and the exchange rate is high.
B) the forward/spot rate difference is either larger or smaller in percentage terms than the difference in the interest rates on two currencies.
C) there is a time lag on the settlement of the transactions.
D) the interest rate is high and the exchange rate is low.

Question

Quizplus · Accepted Answer

Covered interest arbitrage can be profitable if the percentage difference between the forward/spot rate and the interest rate differential is large enough to cover transaction costs. Therefore, option B is the correct answer as it describes the conditions needed for covered interest arbitrage. Option A and D are incorrect as they denote only the direction of interest rates and exchange rates, which is not sufficient information to determine an arbitrage opportunity. Option C is also incorrect as transaction settlement time does not affect the opportunity for covered interest arbitrage.

There Can Be an Opportunity for Covered Interest Arbitrage If