Currently, the spot exchange rate is $1.40/£ and the six-month forward exchange rate is $1.38/£. the six-month interest rate is 4.0% per anum in the u.s. and 2% per annum in the u.k. assume that you can borrow as much as $1,400,000 (in the US) or £1000000 (in the u.k.)
a) determine whether the interest rate parity (IRP) is currently holding.
b) if the IRP is not holding, how would you carry out covered interest arbitage? Show all the steps and determine the arbitrage profit.
c) explain how the IRP will be restored as a result of covered arbitrage activities. What changes might happen?