Question

HW2: Interest Rate Parity with bid-ask spreads

Suppose:

 Spot rate St = $1.5080 - $1.5095 / £

 Six month Forward rate Ft,t+6 = $1.5280 – 1.5292/£

 Interest rate in US = 4.6% – 4.8%

 Interest rate in UK = 3.0% – 3.3%

With bid-ask rates and borrowing-lending rates, is arbitrage profit possible if you start with $1 million in part (a) and £ 1 million in part (b) ? Do it both ways :

(a) borrow $ 1 million in US and invest overseas and

(b) borrow £ 1 million in UK and invest in US.

Answer 1