David Jensen is a foreign exchange trader with Citibank who has access to $1,500,000 US or the Euro equivalent. He notices the following US dollar (USD) and Euro (EUR) foreign exchange and interest rate quotes:

Spot exchange rateUSD 1.1374 /EURSix months forward exchange rateUSD 1.1441 /EURExpected spot exchange rate in six monthsUSD 1.1510 /EURSix months $ interest rate1.5% per yearSix months EUR interest rate0.4% per year

Required:

1. In the context of interest rate parity, under what conditions would an interest rate arbitrage be possible?(2 marks)
2. Show the steps David would need to take to realise a covered interest rate arbitrage profit and calculate the profit?(7 marks)
3. Discuss how a covered interest arbitrage strategy is different to an uncovered interest arbitrage strategy?(2 marks)