Given the following information:

All interest rates are quoted in annual nominal terms (they are not effective interest rates).

Spot: USD/SGD 1.3569 / 1.3574

3-month Forward Points: USD/SGD -204 / -201

U.S. (USD) Interest Rates (Investing, Borrowing): 1.8%, 3.2%

Singapore (SGD) Interest Rates (Investing, Borrowing): 0.4%, 1.6%

Assume that you have calculated that the forward rate implied by interest rate parity is around 1.3475.

What would be the percentage return from engaging in Covered Interest Arbitrage? (Calculate as a percentage of your initial borrowing, accurate to 2 decimal places).

ANSWER

You must compare the actual forward to the implied (theoretical) forward rate.

You must find the USD is relatively undervalued.

You must borrow USD and engage in CIA (doesn't matter how much you borrow)

You must find an arbitrage profit of 0.77% of your initial borrowing