Consider the following information available in Diamond Bank located in a neighborhood near you.
Spot Rate for the British Pound Sterling $1.60
90 – day forward rate of the pound $1.59
90 – day UK interest rate 4%
90 – day U.S. interest rate 3%
(a) Given this information, would it be a prudent strategy for Diamond Bank to engage in covered interest arbitrage? Explain.
(b) If covered interest arbitrage is profitable how much profit would the Bank earn if it uses $1,000,000?
(c) Briefly discuss the realignment process that will yield interest rate parity.