Suppose a Canadian investor has CAD 1 million to invest for 90 days. The current spot rate between CAD and USD is that 1 USD = 1.1239 CAD. He is considering two options:

Option 1: He can invest this money in a local bank in Toronto and earn annualized return of 0.75%.

Option 2: Alternatively, he could sell his Canadian dollars for US dollars and place a USD deposit in Chicago and earn 0.4% annualized return.

Required:

A) Assuming that the borrowing and lending rate is the same within each country, what is theoretical 90-day forward rate between Canadian dollar and US dollar that makes the investor indifferent between the two options (ignoring transaction costs and taxes)? Define covered interest parity. You may use a diagram to assist your answer.

B) Assuming the actual 90-day forward rate is 1.1200. Explain how the investor could make a profit without risk and without investing any of his own money (ignoring transaction costs and taxes).