Suppose that you are a foreign exchange trader for a bank based in New York. You are faced with the following market rates:

Spot exchange rate: $1.1500/

1 year dollar interest rate = 2.50%

1 year pound interest rate = 1.75%

1 year forward exchange rate: = $1.1625/ a)

a) Is there a Covered Interest Arbitrage (CIA) opportunity here? Explain why or why not with calculations. (5 points)

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b) Given the data in part (a), spell out the actions you would take to profit from this situation: Which currency would you borrow and which currency would you lend (invest)? What is the forward transaction you would engage in? Note that you do not have to solve the problem or provide any detailed calculations of arbitrage profits. (5 points)

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