Covered Interest Arbitrage (10 points). A foreign currency trader, authorized to trade $1,000,000, faces the following quotes:

Spot rate: SFr 1.2810/$

3-month forward rate: SFr 1.2740/$

US dollar interest rate: 5% per year

Swiss franc interest rate: 3% per year

Does an arbitrage opportunity exist? If yes, please explain the arbitrage strategy, calculate the traders profit, and describe the impact of the arbitrage trading on exchange rates and interest rates.

a) Check if an arbitrage opportunity exists

b) Describe the arbitrage strategy and calculate the traders profit. (Be specific. Show all calculations and currency units)

c) Describe the impact of the arbitrage trading on exchange rates and interest rates. (Be specific).

Impact on Spot rate (which currency appreciates/depreciates against which currency):

Impact on Forward rate (which currency appreciates/depreciates against which currency):

Impact on US interest rate:

Impact on Swiss interest rate: