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Interest ArbitrageUncovered interest arbitrage: making foreign financial investments without obtaining “cover” for exchange rate riskExample: Annual 3-monthsU.K. 3-month Treasurybill interest rate 10% 2.5%U.S. 3-month Treasurybill interest rate 6% 1.5%Uncovered interestdifferential 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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