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I'm fairly certain there is supposed to be a profit from this, can someone double check my work and advise me where I went wrong, as well as provide the correct solution and associated steps?

1 Suppose that you're a FX trader for a bank in New York. You are faced with the following market rates: Spot exchange rate: $1.4000/. 1 year dollar interest rate = 0.75% 1 year pound interest rate = 1.25% 1 year forward exchange rate: = $1.3850/. a) Is there a Covered Interest Arbitrage (CIA) opportunity here? Explain why or why not. (4 points) Yes, there is CIA opportunity here. There is a difference in the 1 year forward exchange rate of $1.3850/ and the theoretical rate of (roughly) $1.406948/. Note: I do have the equation I used in an excel spreadsheet and used the following formula to calculate theoretical rate: =1.4*(1+0.0125) 41+0.0075)) b) Continuing with the problem, spell out the actions you would take to profit from this situation. Assume that you can borrow up to $10,000,000 in dollars or its equivalent in pounds engage in this arbitrage. Your response should include step- by-step verbal explanations as well as detailed calculations. Which currency and how much of it would you borrow? Which currency and how much would you lend invest)? (2 points) What is the forward transaction you would engage in? Specify which currency and what quant of that currency you would sell forward and the quantity of the currency you would buy forward. (2 points) Calculate the amount of arbitrage profits? Clearly explain your calculations in words. (2 points) . Operating under the assumption that since actual rate was less than the theoretical rate, we know that the actual rate is undervalued. To make some profits, you will need to sell $ with the spot rate and buy in forward. Here are the exact steps you will take. Today: 1) Get $10,000,000 for 12 months. 2) Buy up pounds at spot using your 10mm and get 7,142,857.14 pounds. (10,000,000 / 1.4) 3) Invest your 7.14mm in pounds for 12 months. 4) Get a forward contract to sell your pounds after 12 months for 7,232,142.85. (7142857.14*(1+.0125)). End of contract: 1) Cash out on your contract and take your 7,232,142.85. (Calculated in step 4 above) 2) Sell your pounds under a forward contract and get back $10,016,517.85. (7,232,142.85*1.385) 3) Repay the 10mm you borrowed along with the interest for 12 months, total of $10,075,000. (10,000,000*(1+.0075)) 4) Arbitrage loss = $58,482.15 (Ctrl)

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