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    covered interest arbitrage/purchasing power parity

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    a)180-day interest rate is 1% & 3% respectively in the US and Japan
    spot rate & 180-day forward rate are equivalent=
    120 yen per one US dollar
    As a trader of a commercial bank how would I invest $1 million and earn risk free return by engaging in covered interest arbitage.

    b)inflation rate in US and Japan & Japan respectively
    Spot rate =$.0083333 per one Japanese Yen or
    How much does US dollar have to depreciate to maintain purchasing power parity?

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    Solution Preview

    Question One:
    Day 0: Do the following transactions
    1. Borrow $1 million at the rate of 1% for 180 days
    2. Sell $1 million in spot market to buy 120 million Yen
    2. Invest 120 million Yen in Japanese market ...

    Solution Summary

    Covered interest arbitrage is discussed.