Question

How much arbitrage profit can you obtain with the following information? Hint. Covered interest arbitrage Spot exchange rate: 1.1 Euro / dollar Forward exchange rate: 1 Euro / dollar Risk free rate in U.S: 3% Risk free rate in Europe: 2%

Answer 1

Forward rate= EURO per USD * (1+Interest rate in EURO)/(1+Interest rate in USA)
Forward rate=	=1.1*(1+0.02)/(1+0.03)
Per USD	1.09
Since given forward rate is 1.00, we can see that some arbitrage opportunity is available
So the funds available are invested in EURO
Loan taken in USD	$        100,000
Equivelent EURO	=100000*1.1
	€        110,000
This is invested in EURO so amount after 12 months	=110000*(1+2%)
	€        112,200
Amount converted back to USD	=112,200/1
	$        112,200
Amount payable in US after 12 months for loan	=100000*(1+3%)
	$        103,000
So this way there will be gain	112200-103000
So this way there will be gain	$            9,200