QUESTION TWO

Suppose the interest rate on Euro is $12\%$ in German, and the interest rate on a comparable Tanzania shillings investment in Tanzania is $7\%.$ The Euro spot rate is TZS $2,750$

and the one$-$year forward rate is TZS $2,680$

Required:

$($i$)$ Are there opportunities for covered interest arbitrage?

$($ii$)$ Is the covered interest differential in favour of Euro? Justify with computations

$($iii$)$ Illustrate the profits associated with covered interest arbitrage by showing the

steps that an arbitrageur can take to profit from the discrepancy in rates based on

$$1,000,000$ transaction. Assume that the borrowing and lending rates are identical

and the bid$$ask spread in the spot and forward market is zero