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Covered Interest Arbitrage. Assume the following information:                                 &nbsp

Covered Interest Arbitrage. Assume the following information:

                                                                                                              Quoted Price

                Spot rate of Canadian dollar                                                  $.90

                90‑day forward rate of Canadian dollar                               $.88

                90‑day Canadian interest rate                                                4.4%

                90‑day U.S. interest rate                                                          1.6%

Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1,000,000.) What market forces would occur to eliminate any further possibilities of covered interest arbitrage?

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Answer #1

Interest arbitrage can be used by taking a loan at the US interest rate then converting it to the Canadian dollar and investing there.

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