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Draw a diagram to illustrate your understanding of the relationship between interest rate parity and covered...

Draw a diagram to illustrate your understanding of the relationship between interest rate parity and covered interest rate arbitrage and the interplay of market forces that will occur to eliminate arbitrage opportunities.

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Relationship between interest rate parity and covered interest rate arbitrage and the interplay of market forces that will occur to eliminate arbitrage opportunities can be drawn as follows :
The middle bold like is referred as the covered interest rate arbitrage line.
Vrtical line shows the difference in interest rate between US Dollar and UK Pound and horizontal line shows the forward premium or discount (- means discount and + means premium)
Both the dotted lines show the situations when there is arbitrage opportunity. Dotted line above shows that funds will flow to US and dotted line below show that the funds will flow to London . However marker forces will ensure that any arbitrage opportunity is exploited and it comes back to equilibrium

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