Here are some prices in the international money markets:

Rates BID ASK

Spot Rate: S ($/) BID ($1.1320/bid) ASK ($1.2712/ask)

Forward rate (one year) BID ($1.3215/bid) ASK ($1.3510/ask)

Interest Rate () BID 5% per year ASK 8.5% per year

Interest Rate ($) BID 4% per year ASK 8.5% per year

a. Assume that (a)-you don't have any money but you have credit to borrow in U.S. or Europe and (b)-

no transaction costs or taxes exist. Do covered arbitrage profits exist in the above situation? Describe the flows

(strategies) and calculate profits in terms of the currency that you borrow from.

Describe all possible strategies and calculate profit:

b.Suppose now that transaction costs in the foreign exchange market equal 0.20% (=0.002) per

transaction. Do unexploited covered arbitrage profit opportunities still exist?