The spot exchange rate and the three-month forward exchange rate of the euro vis--vis the US dollar are quoted in New York as follows:

S0 = $1.1877/ with a spread 075 - 079

F0,90 = $1.1822/ with a spread 020 - 024

The interest rate at which the trader can borrow or lend in the US is 2.75% per annum, and it is expected to remain unchanged in the next three months;

The interest rate at which the trader can borrow or lend in Euroland is 3.25% per annum now, and it is expected to remain unchanged in the next three months.

Required: (a)Ignoring transaction costs, what should be the US interest rate if CIRP holds while other figures remain unchanged? (8 marks)

(b)Set up procedures to exploit the arbitrage opportunities. Work out how big the arbitrage profit is, taking into account the transaction costs in the foreign exchange market as indicated by the bid-ask spread in the quotations. (12 marks)