HJ, an abitrager with Bank of Montreal, faces the following CAD/USD prices;
Spot: CAD 1.49/USD
6M Forward: CAD 1.51/USD
6M CAD interest rate 7.5% per annum
6M USD interest rate 5.0% p.a.
H.J is authorized to use CAD20,000,000 or its USD equivalent. The ending profit, if any, should be realized in CAD. How can he complete interest arbitrage? What will be his profit?
Day 0: Do the following transactions
1. Borrow CAD 20 million at the rate of 7.5% for 6 days
2. Sell CAD 20 million in spot market to buy USD
The amount of USD received = 20.0 Million / Exchange rate = 20.0 Million / 1.49 = 13.422819 million USD
3. Invest the proceeds from sale of CAD in US Bank for 180 days ...
A discussion of covered interest arbitrage ensues.