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:

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.

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S(0) 1.5250-1.5260 F(90) 1.5068-1.5073 with 12- and 3-month Eurocurrency interest rates, respectively, at ius(360) = 91% -9% or ius(90) = 2.27% -2.30% JUK (360) 14% -14% or UK (90) = 3.50% -3.63% =