• Suppose the spot rate between Euro Suppose the spot rate between Euro and USD is 0.8700 USD per Euro. 90-and USD is 0.8700 USD per Euro. 90-day forward is 0.8500.Dollars can be day forward is 0.8500.Dollars can be lent or borrowed at a rate of 5% p.a lent or borrowed at a rate of 5% p.a while the rate for euro deposits or while the rate for euro deposits or loans is 8%p.a. Is there an loans is 8%p.a. Is there an opportunity for arbitrage?opportunity for arbitrage?

Covered Interest Covered Interest Arbitrage Arbitrage • Borrow 100 Euros @ 8%p.a Borrow 100 Euros @ 8%p.a • Convert into USD spot 100x0.87 =$87Convert into USD spot 100x0.87 =$87• Deposit $87 for 90 days @ 5%p.a = Deposit $87 for 90 days @ 5%p.a =

$88.0875$88.0875• Convert it to Euro forward Convert it to Euro forward

=88.0875/.85=103.63=88.0875/.85=103.63• Repay Euro loan Repay Euro loan = = 102.00 102.00• Arbitrage profit Arbitrage profit = = 1.63 1.63

• Consider the following data:Consider the following data:

• Gbp/usd: 1.7500/10Gbp/usd: 1.7500/10

• 3 month forward: 1.7380/1.74003 month forward: 1.7380/1.7400

• 3-month eurodollar:8.00/8.20% p.a3-month eurodollar:8.00/8.20% p.a

• 3-month euro sterling: 10.50/11.005 3-month euro sterling: 10.50/11.005 p.ap.a

• Check whether there is a covered Check whether there is a covered interest arbitrage.interest arbitrage.

• Borrow $1for 3 months at 8.20% p.a., convert to Borrow $1for 3 months at 8.20% p.a., convert to • GBP(1/1.7510) = GBP 0.5711, invest GBP at 10.50% GBP(1/1.7510) = GBP 0.5711, invest GBP at 10.50%

p.a. for three months; maturity value GBP p.a. for three months; maturity value GBP 0.5711[1+(0.1050/4)] = GBP 0.5861, which sold 0.5711[1+(0.1050/4)] = GBP 0.5861, which sold forward at 1.7380 yields $1.0186. Repayment of forward at 1.7380 yields $1.0186. Repayment of dollar loan requires $1.0205 = 1+(0.0820/4). Net dollar loan requires $1.0205 = 1+(0.0820/4). Net loss.loss.

• Borrow GBP 1 at 11%; convert spot to $1.7500; Borrow GBP 1 at 11%; convert spot to $1.7500; invest at 8.0% p.a.; maturity value of deposit invest at 8.0% p.a.; maturity value of deposit 1.75(1.02) = $1.7850; sold forward at $1.7400 per 1.75(1.02) = $1.7850; sold forward at $1.7400 per GBP yield GBP(1.7850/1.7400) = GBP 1.0259; GBP yield GBP(1.7850/1.7400) = GBP 1.0259; repayment of GBP loan requires GBP [1+(0.11/4)] = repayment of GBP loan requires GBP [1+(0.11/4)] = GBP 1.0275. Again net loss.GBP 1.0275. Again net loss.

• Hence no covered interest arbitrage opportunity.Hence no covered interest arbitrage opportunity.