Question

Assume you have $1,000,000 to invest Current spot rate of the pound = $1.30 90 day forward rate of pound = $1.28 3 month deposit rate in US = 3% 3 month deposit rate in Great Britain = 4% If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S.dollars you will have after 90 days? Show your work.

Answer 1

$1,024,000

Step-by-step explanation:

with your $1,000,000 you can currently buy $1,000,000 / $1.3 = £769,231

then you invest your £769,231 and receive = £769,231 x (1 + 4%) = £800,000

since the forward rate for three months = $1.28, then at the end of the three months you will have £800,000 x $1.28 = $1,024,000

if you simply invested your money in the US, you would earned more money ? $1,000,000 x (1 + 3%) = $1,030,000. You lower gains are the result of the British pound depreciating against the dollar.