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.

a) Does interest rate parity hold?

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.

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

d) Determine arbitrage potential in b) using spot rate after six months of RON/US $= 4.25 rather than 6-months forward rate.