Question

Let's suppose you have $1 million to invest.

You are considering to invest in UK first, then convert the British Pound back to US$ in the future.

You know the following information:

The annual Interest rate on investment in UK: 4%

Investment period: 1 year

Current exchange rate: 1.48 $/BP

Forward exchange rate which you can apply when converting BP to US$: 1.47 $/BP

What would be profit if you apply the covered-interest arbitrage?

A) About $40,542

B) None of the above

C) About $48,382

D) About $24,254

Answer 1

Solution :-

First Convert $1,000,000 into Pound at $1.48/pound

= $1,000,000 / $1.48

= Pound 675,675.67

Now invest pound at 4% per year

Pound after a year =

= 675,675.67 * 1.04 = Pound 702,702.703

Now convert pound in dollar at $1.47/ pound

Now = 702,702.703 * 1.47 = $1,032,972.97

As no interest of US given assume zero.

Covered interest arbitrage = $1,032,972.97 - $1,000, 000 = $32,972.97

Therefore correct answer is (b) none of the above

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