1)The U.S. dollar (USD) deposit interest rate is 1%, while Australia’s (AUD) rat

1)The U.S. dollar (USD) deposit interest rate is 1%, while Australia’s (AUD) rate is
3.5%, with a 1.5000 AUD/USD exchange rate.
a) Explain Interest Rate Parity (IRP).
b) What should be the 1-year forward exchange rate for AUD/USD under Interest
Rate Parity?
2) The spot exchange rate for USD /euro is 1.15; the forward rate in 6 months for USD
/ euro is 1.12. US interest rate is 1.5% per year while Europe interest rate is 2.5%
per year. You have 1,000,000 Euro to invest.
a) Explain Covered Interest Arbitrage.
b) Calculate the amount of USD you will have in 6 months, including interest
income, by converting euro in spot rate and invest in US interest rate;
c) Calculate the amount of euro you will have in one year by converting the USD
back to Euro using the forward rate;
c) What’s will be the arbitrage profit in 6 months for 1,000,000 Euro using Covered
Interest Arbitrage?