Final answer:
Covered interest arbitrage is an investment strategy used to capitalize on interest rate differentials between two countries while hedging exchange rate risk with forward contracts. It can be profitable, depending on the conditions of the currency markets and the costs associated with hedging strategies.
Step-by-step explanation:
The student has asked whether Heidi Høi Jensen, a foreign exchange trader at J.P. Morgan Chase, can make a profit from covered interest arbitrage (CIA) with an investment of $5 million in Denmark. A covered interest arbitrage is an investment strategy where an investor takes advantage of the interest rate differential between two countries while hedging exchange rate risk by using forward contracts. Hedging is a financial strategy used to protect against the risks of adverse currency movements, such as fluctuations in the dollar/euro exchange rate. When engaging in such transactions, financial institutions often facilitate hedging and may charge a fee or create a spread in the exchange rate.
In the context of international finance, demand and supply dynamics for a currency on the foreign exchange market can affect the currency's value. For example, when international financial investors buy U.S. government bonds, they increase the demand for U.S. dollars, which can lead to an appreciation of the dollar's exchange rate against other currencies, such as the euro.