Answer :
To calculate the covered interest arbitrage profit, we need to follow these steps:
1. Calculate the interest earned in each country:
- In the US: USD 10,000,000*
7% = USD 700,000
- In Canada: CAD 12,500,000 *
5% = CAD 625,000
2. Convert the interest earned in Canada to USD using the spot rate:
- CAD 625,000 * $0.80 = USD 500,000 3. Calculate the forward amount in CAD after one year: - Forward CAD amount = CAD 12,500,000 $0.812 = USD 10,150,000
4. Calculate the total USD received after converting the forward CAD amount:
Total USD = USD 700,000 + USD 500,000 = USD 1,200,000
5. Calculate the profit made from covered interest arbitrage: - Profit = Total USD - USD 10,000,000 = USD 1,200,000 - USD 10,000,000 = USD
Therefore, the covered interest arbitrage profit should be USD 200,000.