Question

The spot rate for the Swiss Franc is $1.0550/SF and the one-year forward rate is $1.0650/SF. The expected one year interest rates are 6% p.a. for the US and 4% p.a. for Switzerland. Using the above rates, can you engage in a covered interest rate arbitrage as an American investor? Use either $1,000,000 or SF 1,000,000 as the notational amount. Show any profits in dollars.

Answer 1

according to interest rate parity therom the currency with higher interst rate will sell in discount in futures market to cancel the arbitrage oppurtunity

us interest 6%

swiss interest 4%

as us interest is higher usd will sell in discount in futures market

arbitage free price is = spot rate *(1+us  rate )/(1+swiss rate)

= 1.0550*(1.06)/(1.04) = 1.0650

and forwrad rate is 1.0650

so arbitragre free price is equal to forward price

so there is no arbitrage oppurtunity so covered interest arbitrage exixts