Covered interest rate arbitrage is possible when:
A) both currencies are appreciating.
B) the actual inflation rates are identical in both countries.
C) the difference in the interest rates in two countries exactly equals the spot-to-forward exchange rate differential.
D) the difference in interest rates in two countries is out of line with the spot-to-forward exchange rate differential.
E) none of the above

Question

Quizplus · Accepted Answer

Covered interest rate arbitrage is possible when the difference in interest rates in two countries is out of line with the spot-to-forward exchange rate differential. In this situation, an investor can borrow in a country with a low-interest rate, convert those funds to a currency of a country with a higher interest rate, and invest those funds in high-yielding instruments. This leads to a profit for the investor, as the higher return on investment covers the cost of borrowing and also provides a profit.

Covered Interest Rate Arbitrage Is Possible When