A US-Based Currency Dealer Has Good Credit and Can Borrow $1,000,000

Multiple Choice

A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year.The one-year interest rate in the U.S.is i_$ = 2% and in the euro zone the one-year interest rate is i_€ = 6%.The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00.Show how to realize a certain dollar profit via covered interest arbitrage.

A) Borrow $1,000,000 at 2%.Trade $1,000,000 for €800,000; invest at i_€ = 6%; translate proceeds back at forward rate of $1.20 = €1.00,gross proceeds = $1,017,600.
B) Borrow €800,000 at i_€ = 6%; translate to dollars at the spot,invest in the U.S.at i_$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00.Net profit is $2,400.
C) Borrow €800,000 at i_€ = 6%; translate to dollars at the spot,invest in the U.S.at i_$ = 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00.Net profit is €2,000.
D) Borrow €800,000 at i_€ = 6%; translate to dollars at the spot,invest in the U.S.at i_$ = 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00.Net profit is €2,000.Alternatively,one could borrow €800,000 at i_€ = 6%; translate to dollars at the spot,invest in the U.S.at i_$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00.Net profit is $2,400.