Assume that the forward exchange rate is for 90 days forward and the interest rates are annualized 90-day rates in Question 9. Can a trader earn covered interest arbitrage profits?
Reference Question 9:
Suppose that the following exchange rates and interest rates prevail:
Spot exchange rate: $1 = 121 yen
One-year forward rate: $1 = 130 yen
One-year interest rates: U.S. = 5.54%, Japan = 6.98%
Can a trader earn covered interest arbitrage profits? If not, explain why not. If possible, determine what the likely directional impact on each rate would be if arbitrageurs took advantage of the profit potential.
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