USD/EUR Spot Rate is 1.2000.
Euro Interest rate = 2%
US Interest Rate = 4%
One Year forward rate = 1.2300
What is the arbitrage on a 1EUR investment?
A) $0.007
B) $0.123
C) $0.135
Is this a carry trade question? I was going to answer it as follows:
1 EUR today convert to USD1.2000
Grow $1.2000 at 1.04% to $1.248
Convert back to Euro at new rate of 1.2300 so $1.248/1.2300 = EUR1.0146
At this stage we also grow the initial 1EUR at 1.02% = 1.02.
How do we calculate the arb profit? Isnt it 1.0146 - 1.02 = -0.0054?
Thanks