. Suppose that the forward rate of in $ is given: F1$/=$1.20/, but all other values are the same (see Slide #21).

First show that the covered interest arbitrage is possible. Then, discuss the arbitrage strategies and its profit in $. Review lecture notes Slide #19, 20, 21, and 22.

4.3 Interest Rate Parity and Covered Interest Arbitrage Interest rate parity: Which way do you go? 4.3 Interest Rate Parity and Covered Interest Arbitrage Interest rate parity: Which way do you go? If F, dif/5, df > [(1+i)/(1+i)] If Fdf/S, d'f (1+i%) / (1+if) 1.041667 > 1.038835 The currency and Eurocurrency markets are not in equilibrium. 4.3 Interest Rate Parity and Covered Interest Arbitrage Covered interest arbitrage 1. Borrow $1,000,000 +$1,000,000 at i* = 7% $1,070,000 2. Convert $s to s 833,333 at S$ = $1.201 $1,000,000 3. Invest s +858,333 at if = 3% -833,333 4. Convert s to $s +$1,072,920 at F $ = $1.25/ -858,333 5. Arbitrage profit = $2,920 Bules / Multinational Finance Be Chapter 4 The International Parity Conditions Butler / Mulbiratiara Firence &e Checker 4 The International Parity Candice 421 4-22 21 22