Question: Suppose that the current spot exchange rate is €1.50/₤ and the one-year forward exchange rate is €1.60/₤. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, i.e., ₤666,667, at the current spot exchange rate.

1. Show how you can realize a guaranteed profit from covered interest arbitrage. Assume that you are a euro-based investor. Also determine the size of the arbitrage profit.
2. Discuss how the interest rate parity may be restored as a result of the above
   transactions.
3. Suppose you are a pound-based investor. Show the covered arbitrage process and
   determine the pound profit amount.
   
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