Suppose that the six-month interest rate is 4.00% per year in the U.S. and 6.00% per year in Germany, and that the current spot exchange rate is $1.20/ and the six-month forward exchange rate is $1.14/ and. Assume that you can borrow at most $1,000,000 or the equivalent euro amount, i.e., 833,333.

a. Describe the covered interest arbitrage process and determine the arbitrage profit. Assume that you would like to realize profits in U.S. dollars.

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