Problem:
One Year Interest rates for US: 5% and UK: 7%. The spot rate is: $1.40/£ and one year forward rate is $1.34/£. If Covered Interest Arbitrage (CIA) is possible show:
1) Who should do the CIA: US investor or UK?
2) Assuming initial wealth is 100,000 unit of local currency, what is the wealth after one trip of CIA
3) If CIA is available what is the maximum rate of return on investment to an US investor? To an UK investor?
4) Now if one year forward rate is $1.372/£. Then what is the maximum return available to UK investor at home and through CIA? US investor at home and through CIA
Show your all work and describe in detail.