Suppose that the 12-month interest rate is 6.0% in the U.S. and 4.0% in Germany, and that the current spot exchange rate is $1.30/ and the 12-month forward exchange rate is $1.35/. You can borrow at most $1,000,000 or the equivalent euro amount, i.e., 769,231.

(1) Describe the covered interest arbitrage process and determine the arbitrage profit. Assume that you are a dollar-based investor (i.e., you want to realize profit in terms of U.S. dollars.).

(2) Explain how the interest rate parity (IRP) will be restored as a result of the covered interest arbitrage.

(3) Assume now that you are a euro-based investor. Show the arbitrage process and determine the profit in euro.