Lecture_19___Fall_2007 - Interest Arbitrage Uncovered...

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Interest Arbitrage Uncovered interest arbitrage : making foreign financial investments without obtaining “cover” for exchange rate risk Example: Annual 3-months U.K. 3-month Treasury bill interest rate 10% 2.5% U.S. 3-month Treasury bill interest rate 6% 1.5% Uncovered interest differential favoring U.K. 4% 1.0% If pound depreciates (from $2.00 to $1.98, or 1.0%), then investor makes less (zero) If pound appreciates (from $2.00 to $2.02, or 1.0%), then investor makes more (2%)
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