Suppose that the current spot exchange rate is 1.50/ and the one-year forward exchange rate is 1.60/. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most 1,000,000 or the equivalent pound amount, i.e., 666,667, at the current spot exchange rate.

Assume that you are a euro-based investor. Show how you can realize a guaranteed profit from covered interest arbitrage and determine the size of the arbitrage profit by answering the following questions:

How the interest rate parity may be restored as a result of the above arbitrage transactions? Answer with either rise or fall. a. Euro interest rate will=_____ b. Pound interest rate will =______ c. Spot exchange rate (euros per pound) will=______ d. Forward rate will=______