Question

Covered Interest Arbitrage. Define the terms covered interest arbitrage and uncovered interest arbitrage. What is the difference between these two​ transactions?

Answer 1

In covered interest rate arbittage, the investor tries to make profit from the difference between the interest rates of two countriew by hedging. This is done by having a forward contract to reduce the risk of the interest rate fluctuations on the arbitrage opportunity.

Uncovered interest rate arbitrage does not have any such provision. The investor canot protect his/her position in the market by hedging through forward contract. Thus, there is more risk involved in uncovered interest rate arbitrage than covered interest rate arbitrage.