Tomoko Matsubara is a currency arbitrager for Showa and company, Yokohama. The spot rate this morning is 120.50 Yen/$, and early indications are that 90-day interest rates in the United States will rise from their current level of 4.125%.
The U.S. Federal Reserve Bank, the central bank, is worried about rising inflation and has been publicly considering raising interest rates 25 basis points (1/4%).
The 90-day forward exchange rate quoted to Matsubara-san by local banks such as Daichi Kangyo are all about the same, 119.60 Yen/$. The current 90-day Yen interest rate is 0.5000% (half of one percent). Matsubara-san has 300 million Yen at her disposal.
a. How can Matsubara-san make a profit through covered interest arbitrage? How much in yen can she hope to make in profit in 90 days?
b. What should Matsubara-san do with her 300 million yen if she wished to speculate through uncovered interest arbitrage? What could she expect to make in profit with this strategy?