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

Spot exchange rate CHF 0.9650 /USD

Six months forward exchange rate CHF 0.9402 /USD

Expected spot exchange rate in six monthsCHF 0.9377 /USD

Six months $ interest rate3.5% per year

Six months CHF interest rate1.4% per year

Required:

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