7. Covered Interest Arbitrage (CIA)

Given the following: US 90day interest rate 5%

Canadian 90day interest rate 10%

Current Spot Rate $0.8512/C$ 90day Forward Rate $0.8501/C$

You have $1 Million and would like to engage in CIA:

i) Outline the steps for CIA with the appropriate computation thereof and compute the profit.

ii) Compute the Return on Investment of $1 million and identify its components:

a) Interest Rate Component and

b) Exchange Gain/Loss Component iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?