Currently, the spot exchange rate is $1.2700/ and the forward exchange rate, with one-year maturity, is $1.2500/. The annual interest rate is 1.0 percent in the U.S. and 2.5 percent in the euro zone. Assume that you can borrow as much as $1,270,000 or 1,000,000.

a. Calculate the covered yield (dollar rate of return without taking any exchange rate risk) for the euro (). You might use the first equation on page 152.

b. Determine whether interest rate parity (IRP) is currently holding.

c. How would you carry out covered interest arbitrage (CIA)? Show step-by-step process and the arbitrage profit. d. Explain how IRP will be restored because of the CIA activities.