2. Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot exchange rate is $1.60/ and the forward exchange rate, with one-year maturity, is $1.58/. Assume that an arbitrager can borrow up to $1,000,000 or 625,000

a. Determine whether the interest rate parity is currently holding.

b. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit.

A. $238.65 B. $14,000 C. $46,207 D. $7,000

Circle the correct answer above and provide the workings to the answer above here:

c. Explain how the IRP will be restored as a result of covered arbitrage activities.