Assume the following information: Quoted Price Spot rate of Canadian dollar $.80

Question

Assume the following information:

                                                                                                 Quoted Price

      Spot rate of Canadian dollar                                                                $.80

      60day forward rate of Canadian dollar                                                $.79

      Annual Canadian interest rate                                                               4%

      Annual U.S. interest rate                                                                    2.5%

      Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1,000,000.) What market forces would occur to eliminate any further possibilities of covered interest arbitrage?

Explanation / Answer

The total liability is $1,000,000.

Now, convert them into Canadian dollar using spot rate =$, 1000, 000/$80

=12,500 Cd

Now invest them at 4% interest rate for 60 days

The interest amount is $83 Cd

The total amount =12,583 Cd

Now convert them at forward rate =$79

The proceeds would be $994,083

Thus, the interest arbitrage is $5,917.

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