Question

Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies. forward realignment arbitrage triangular arbitrage covered interest arbitrage locational arbitrage

Answer 1

Answer: The options are given below:

a. forward realignment arbitrage

b. triangular arbitrage

c. covered interest arbitrage

d. locational arbitrage

The correct option is C. Covered Interest Arbitrage

Explanation: Covered interest arbitrage is a technique whereby an investor uses a forward contract to hedge against exchange rate risk. Covered interest rate arbitrage is the practice of using favorable interest rate differentials to invest in a higher-yielding currency, and hedging the exchange risk through a forward currency contract.

Covered interest arbitrage is possible if and only if the cost of hedging the exchange risk is lower than the additional return generated by investing in a higher-yielding currency - hence the word, arbitrage.

When there is a small market or there exists a high level of competition, then the possibility will occur that the earnings on covered interest rate arbitrage will not yield much.

Answer 2

Covered Interest Arbitrage

Step-by-step explanation:

The Covered Interest Arbitrage is a term that refers to arbitrage trading approach in which a stockholder take the chance to gain advantage from the disparity in interest rate between two nations.

The trading strategy helps in its verifiability, quantifiability, consistency, and objectivity

It is designed to profit the investor from the differences in interest rates between two countries, when buying and selling foreign currencies.

When a market is small or there's a high level of competition, there's a possibility that the earnings on covered interest rate arbitrage won't yield much.