Question

Assume the current spot rate is CAD1.3610 and the 1-year forward rate is CAD1.3550. The nominal risk-free rate in Canada is 2.23 percent while it is 2.16 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S. for one year.

		$0.0036
		$0.0040
		$0.0044
		$0.0048
		$0.0052

Answer 1

Correct Option is $0.0052.

Calculations :

Under covered interest arbitrage

Profit = { $ Invested Converted into CAD * (1 + Canada interest Rate) ] / 1 - year Forard Rate} - { $ Invested (1 +U.S interest Rate)}

= {[$ 1 * CAD1.3610 * (1 + 0.0223)]($1 / CAD 1.3550} - {$ 1 * (1 + 0.0216)}

= {1.3913503 / 1.3550} - $1.0216

= $1.02682678966 - $1.0216

= $0.0052

Using covered interest arbitrage you can earn an extra $0.0052 profit over that which you would earn if you invested $1 in the U.S. for one year.