When I R P does not hold, the situation gives rise to covered interest arbitrage opportunities, allowing certain profits to be made without the

arbitrageur investing any money out of pocket or bearing any risk.

For example, consider the following market conditions:

$-$U$.$S$.$ interest rate is $5$ percent.

$-$U$.$K$.$ interest rate is $8$ percent.

Spot exchange rate is $$\frac{1\mathrm{.}80}{}.$

One$-$year forward exchange rate is $$\frac{1\mathrm{.}78}{}.$

An arbitrager can borrow $$1,000,000$ or $555,556.$

How much profit you can make?

Suppose that the treasurer of IBM has an extra cash reserve of $$100,000,000$ to invest for six months. The six$-$month interest rate is $8$

percent per annum in the United States and $7$ percent per annum in Germany. Currently, the spot exchange rate is $1\mathrm{.}01$ per dollar and the six$-$

month forward exchange rate is $0\mathrm{.}99$ per dollar. The treasurer of IBM does not wish to bear any exchange risk. Where should they invest to

maximize the return?

$($CFA question$)$ Omni Advisors, an international pension fund manager, uses the concepts of purchasing power parity $($PPP$)$ and the

International Fisher Effect $($IFE$)$ to forecast spot exchange rates. Omni gathers the financial information as follows:

Calculate the following exchange rates $($ZAR and USD refer to the South African rand and U$.$S$.$ dollar, respectively$).$

a$.$ The current ZAR spot rate in USD that would have been forecast by PPP$.$

b$.$ Using the IFE, the expected ZAR spot rate in USD one year from now.

c$.$ Using PPP$,$ the expected ZAR spot rate in USD four years from now.