Suppose that the treasurer of IBM has chance to borrow of$10,000,000 (or its equivalent in other currency) and to invest forthree months. Monthly interest rate in the USA - 1.3% per month, inGermany - 0.6% per month, in London - 0.9% per month. The treasurerof IBM does not wish to bear any exchange risk.
Current spot exchange rate: 0.8045 €/$ and 1.8095 $/£
Three-month forward exchange rate: 0.8098 €/$ and 1.8028 $/£
a. Determine whether the interest rate parity (IRP) is currentlyholding.
b. If the IRP is not holding, how would you carry out coveredinterest arbitrage? Show all the steps and determine the arbitrageprofit.
c. Explain how the IRP will be restored as a result of coveredarbitrage activities.
