a)A currency dealer based in Illinois with good credit is able to borrow $1,000,000 for one year. He plans to invest the money in a different country and decided in Germany. The interest rate for one year in the U.S. is 2 percent and in Germany, the euro for oneyear interest rate is 6 percent. The spot exchange rate is $1.25 = 1.00 and the oneyear forward exchange rate is $1.20 = 1.00. Show how this dealer can realize a certain dollar profit through covered interest arbitrage.

b)Sigmund is a pound-based investor. Suppose that the current spot exchange rate is 1.50/ and the three-month forward exchange rate is 1.58/. The three-month interest rate is 6.0% per annum in euros and 5.2% per annum in pounds. Sigmund can borrow at most 1,000,000 or the equivalent pound amount. Show how Sigmund can realize a guaranteed profit.

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