QUESTION 3 (20 MARKS)

Use the following information to answer the questions. Spot rate: $0.055/ZAR 3-month forward rate: $0.058/ZAR. 3-month U.S interest rate: 8.5%

3-month South Africa interest rate: 6.46% a) Show your calculation to determine whether the interest rate parity (IRP) holds.

b) If the IRP does not hold, how would you carry out covered interest arbitrage? Show all the steps and then determine the arbitrage profit. Assume that you can borrow as much as $1,500,000 or ZAR 27,272,727 to perform the covered interest arbitrate.

(12 marks)