Suppose that the current spot exchange rate is $0\mathrm{.}84$ per $ and the three$-$month forward exchange rate is $0\mathrm{.}8213$ per $$.$ The three$-$month interest rate is $5\mathrm{.}60$ percent per annum in the United States and $5\mathrm{.}40$ percent per annum in France. Assume that you can borrow up to $$1,000,000$ or $840,000.$

Required:

How will you realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U$.$S$.$ dollars? What will be the size of your arbitrage profit?

Profit via covered interest arbitrage

Borrow in dollars and invest in euros. Hedge exchange rate risk by buying euros forward.

Borrow in dollars and invest in euros. Hedge exchange rate risk by selling euros forward.

Borrow in euros and invest in dollars. Hedge exchange rate risk by buying euros forward.

Borrow in euros and invest in dollars. Hedge exchange rate risk by selling euros forward.

Arbitrage profit$=$

Assume that you want to realize profit in terms of euros. Show the covered arbitrage process and determine the arbitrage profit in euros. How will you realize a certain profit and size of your arbitrage profit?

How will you realize a certain profit?

Arbitrage profit

Borrow in dollars and invest in euros. Hedge exchange rate risk by selling all your euros forward.

Borrow in dollars and invest in euros. Hedge exchange rate risk by selling just enough euros forward to repay your dollar loan.

Borrow in euros and invest in dollars. Hedge exchange rate risk by selling all your euros forward.

Borrow in euros and invest in dollars. Hedge exchange rate risk by selling just enough euros forward to repay your dollar loan.

Arbitrage profit