Shortcut to profit from covered interest arbitrage?

CFA Level II
#1

Q 120 schweser Test 3 PM.

Seems like a lot of steps!! Does anyone have a shortcut?? I doubt that I can remember this mess…

#2

I don’t know what all of their steps are, but it’s pretty straightforward; I wrote an article on pricing currency forwards that goes through a couple of examples: http://financialexamhelp123.com/covered-interest-rate-parity-irp-pricing-currency-forwards/.

#3

Thank you so much! The article helped a lot! I also came across this formula on how to calculate the profit directly and avoid the steps ( 1 + rd - (1 + rf) * F / S ) * initial amt borrowed. Now hoping it shows up on the exam for some easy points! :slight_smile:

#4

in my notes…all the while i thought it was ( 1 + rd - (1 + rf) *S / F ) …

so the correct short cut is ( 1 + rd - (1 + rf) *F / S ) ya??

#5

Can we use this formula all the time? Regardless what currency we start with ?

Thanks

#6

Yes, from what I understand, you just plug in all your numbers in that formula (make sure you follow numerator/denom rule, if F is quoted as rd/rf, then you plug in rd as your first currency), if you get a minus, then you borrow the rd currency and invest in rf, the opposite for a positive number.

PeterPan, it should be F/S. I tried S/F and the answer comes out wrong.

#7

Guys, can somebody please post the numbers for the last question in Test 3 PM schweser? I wanted to re-do that problem (covered interest arbitrage) but I left my book at home. It’s the last paragraph in the last vignette.

#8

thanks IVC…

can i check with u…if your currency denote in d/f?

#9

PeterPan, yes, both F and S are quoted as d/f (domestic/foreign)

#10

noted…thanks!!! :slight_smile: