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Covered Interest Arbitrage Profits

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The following interest rate and exchange rates are listed in London:
RUS: 4.6%-5.00%
REUR: 3.00%-3.4%
Spot Rate: EUR/USD 1.2280-1.2295
Forward Rate (1 Year) : EUR/USD 1.2390-1.2410
Assume that you have 10,000,000 EUR or USD 12,280,000 credit line to execute arbitrage. Can you generate covered interest arbitrage profits? What would be your profit?

A. USD147,869

B. EUR 10,427.07

C. EUR23,939

D. Transaction costs does not allow arbitrage!

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Answer: B. EUR 10,427.07

Deposit rate Borrowing rate
Interest rate Bid rate Ask rate Mid rate
USD 4.60% 5.00% 4.80% =(4.6%+5.%)/2
EUR 3.00% 3.40% 3.20% =(3.%+3.4%)/2

Bid Ask Mid rate
USD/EUR USD/EUR
Spot rate 1.2280 1.2295 1.2288 =(1.228+1.2295)/2
Forward rate 1.2390 1.2410 1.2400 =(1.239+1.241)/2

Using interest rate ...

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The solution solves a problem on covered interest arbitrage with calculations included in Excel.

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Covered Interest Arbitrage

7. Covered Interest Arbitrage (CIA)

7. Covered Interest Arbitrage (CIA)

Given the following:

US 90-day interest rate 5%
Canadian 90-day interest rate 10%
Current Spot Rate $0.8512/C$
90-day Forward Rate $0.8501/C$

You have $1 Million and would like to engage in CIA:

i.) Outline the steps for CIA with the appropriate computation there of and compute the profit.

ii) Compute the Return on Investment of $1 million and identify its components:

a) Interest Rate Component and
b) Exchange Gain/Loss Component

iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?

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