# Covered Interest Arb Question

Anyone have a quick way of doing these? This is from the Schweser QBank Assume an investor living in Italy can borrow in the domestic Lira (ITL) or in the foreign French Franc (FRF). Given the following information, determine whether an arbitrage opportunity exists. If so, how much would the investor profit by borrowing ITL 44,280,000 or the equivalent in FRF? (Assume a period of one year & state the profit in domestic currency terms). Spot rate (ITL/FRF) 295.20000 Forward rate (ITL/FRF) 299.10000 Domestic (Italian) interest rate (%) 5.00000 Foreign (French) interest rate (%) 3.50000 A) An arbitrage opportunity results in a profit of ITL 1,424,774. B) An arbitrage opportunity results in a profit of ITL 58,725. C) No arbitrage opportunity. D) An arbitrage opportunity results in a profit of ITL 2,250

B? I am not getting any of the answers exactly though? IR Parity relation ==> (299.1/295.2) * (1.035 / 1.05) = .998737 which implies arbitrage opportunities exist . profit should be(1 - .998737) * 44,280,000 = 55925.64

I have got the exact answer (b) since (299.1/295.2)

Its B and the easiest way is Interest Rate in ITL 5% Equivalent Rate in France : 299.1/295.2*1.035= 4.87% Arbitrage= Amount Borrowed * Inteerest Diff = (5-4.87)/100 * 44,280,000 ITL =58,725 ITL

Correct answer is B. Thanks everyone.

For direct quotes (DC/FC) if r(domestic) - r(foreign) < (Forward-Spot)/Spot ------------- borrow domestic for r(domestic) - r(foreign) > (Forward-Spot)/Spot ------------- borrow foreign In this case: 5% - 3.5% > (299.1-295.2)/295.1 … therefore borrow FRF