Suppose that the U.S. dollar-pound sterling spot exchange rate equals $1.60/£, while the 360-day forward rate is $1.64/£. The yield on a one-year U.S. treasury bill is 9% and that on a one-year U.K. treasury bill is 8%. Is there an arbitrage opportunity? What should U.S.-based investors do to take advantage of the opportunity? Which country would you expect to face capital inflows and which to face capital outflows? If many investors pursue this opportunity, what would happen to the forward exchange rate, assuming other rates don’t change?

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To determine if there is an arbitrage opportunity we can compare the potential returns from investin... View the full answer