Quiz Time: Covered Interest Arbitrage

Consider a US investor who can borrow 1000 or the equivalent in Euros. The current spot rate is 1.5 /Euro, and the forward rate is 1.6$/Euro. The US interest rate is 5% and the Euro rate is 7%. Is there an arbitrage opportunity? If so how would you take advantage, and what is payoff?

Arb. free forward rate is 1.47$/Euro, but the forward rate is 1.6$/euro. Follow the abitraging: Sell Foward at 1.6$?euro Borrow dollar loan at 5% Buy Euro at spot at 1.5$/euro lend at 7% in euro at forward expiration, receive dolloar at 1.6$/euro Pay off dallor borrowing I have question, what is if forward are is below the arb. rate… i.e. let say 1.3$/euro…can some one tell me the step by step…

borrow $1kus, convert to Euros = 666.66 euros. invest at 7% for a year, you have 713.33 euros. convert back to US as the 1.6 = $1141.33. pay back the $1050 = $91.333 profit?

bingo Bannisja $91 profit.

one of the few things i can do in about 30 seconds. that and tri-arb on the econ vignette and i’d be a happy girl.