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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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    Solution Preview

    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 ...

    Solution Summary

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

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