15. Interest rate arbitrage with bid-ask spreads (advanced). Consider the configuration of bid-ask spot and 90-day forward US$/£ exchange rate on June 12, 2013, keeping in mind that the lower rate is the selling/lending rate and conversely the higher rate is the buying/borrowing rate:

S(0) = 1.5250 − 1.5260 F(90) = 1.5068 − 1.5073 with 12- and 3-month Eurocurrency interest rates, respectively, at:

iUS(360) = 9 1 16%−9 3 16% or iUS(90) = 2.27%−2.30%

iUK(360) = 14%−141 2% or iUK(90) = 3.50%−3.63%

a. Compute the no-profit bid-ask 90-day forward rates.

b. Show how interest rate arbitrageurs can take advantage of the gap between no-profit and market bid-ask forward rates.

c. Explain how such arbitrage transactions should narrow the gap.