Suppose that the annual interest rates on 6-months borrowing in Romania and the United States are 12.7 % and 0.8 %, respectively. The current spot rate RON/US$ is 4.00 and 6-months forward rate RON/US$ is 4.21.

1. a) Does interest rate parity hold?

2. b) Can arbitrage profits be made? If yes, assuming that Romania is your home country, would you

   borrow 4,000,000 RON in Romania or 1,000,000 US$ in the United States? Calculate your

   arbitrage profit.

3. c) Would it be as a result of covered or uncovered interest arbitrage, why?

4. d) Determine arbitrage potential in b) using spot rate after six months of RON/US $= 4.25 rather

   than 6-months forward rate.