Question
A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i
A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i$= 3% and in the euro zone the one-year interest rate is i= 2%. The spot exchange rate is $1.25 = 1.00 and the one-year forward exchange rate is $1.24 = 1.00. Show how to execute acoveredinterest arbitrage and realize a riskless profit. Be sure to calculate the intrinsic interest rate in the United States (3 out 15 points), and explain clearly how to execute the covered interest arbitrage through borrowing/lending and buying/selling forwards (12 out of 15 points).
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