covered interest arbitrage


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Covered interest arbitrage

Occurs when a portfolio manager invests dollars in an instrument denominated in a foreign currency and hedges the resulting foreign exchange risk by selling the proceeds of the investment forward for dollars.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Covered Interest Arbitrage

A strategy in which one enters a long position in an investment in a foreign currency and simultaneously enters a short position in a forward contract on that same currency. The amount one receives in the sale of the forward contract should equal what one spends on the long investment in the base currency. One enters the short position in order to hedge the exchange risk.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

covered interest arbitrage

the borrowing and investing of foreign currencies to take advantage of differences in INTEREST RATES between countries. For example, a company could borrow an amount of one currency (say, the UK pound (£)), convert this into another currency (say, the US dollar ($)) and invest the proceeds in the USA. Concurrently, the company would sell $s for £s in the FORWARD MARKET for delivery at a future specified date. The company would earn a profit on such a transaction if the rate of return on its investment in the USA was greater than the combined expenses of interest payments on the amount of £s borrowed and the costs of concluding the forward exchange contract. Covered interest ARBITRAGE takes advantage of (and in the process eliminates) any temporary discrepancies between relative interest rates in two countries and the forward exchange rate of the two countries' currencies.
Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson

covered interest arbitrage

the borrowing and investing of foreign currencies to take advantage of differences in INTEREST RATES between countries. For example, a company could borrow an amount of one currency (say, the UK pound (£)), convert this into another currency (say, the US dollar ($)) and invest the proceeds in the USA. Concurrently, the company would sell $s for £s in the FUTURES MARKET for delivery at a future specified date. The company would earn a profit on such a transaction if the rate of return on its investment in the USA were greater than the combined expenses of interest payments on the amount of £s borrowed and the costs of concluding the forward exchange contract. Covered interest ARBITRAGE takes advantage of (and in the process tends to eliminate) any temporary discrepancies between relative interest rates in two countries and the forward exchange rate of the two countries’ currencies. See INTERNATIONAL FISHER EFFECT.
Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in periodicals archive ?
(2008) also discover that a) covered interest arbitrage gains are more likely to occur in periods of high volatility or in illiquid markets; and b) the deviations from CIRP conditions (i.e., the arising of pure arbitrage opportunities) in those major global currency and capital markets tend to be short-lived.
Witte (2013), "The Microstructure of Covered Interest Arbitrage in a Market with a Dominant Market Maker," Journal of International Financial Markets, Institutions and Money 24: 25-41.
"A classroom exercise to simulate triangular and covered interest arbitrage." Journal of Financial Education 30 (Summer): 73-86.
Indian Currency and Finance [Keynes, 1913] explored the working of the gold-exchange standard and the need for a reserve bank to manage India's participation in it; The Economic Consequences of the Peace [Keynes, 1919] argued that the transfer problem made the reparations clauses of the Versailles Peace Treaty unworkable; A Tract on Monetary Reform [Keynes, 1923] exposed the social costs of hyperinflation, discussed inflation as a tax on holding money and government bonds, and analyzed covered interest arbitrage in the forward market for foreign exchange in the resulting world of floating exchange rates [Dimand, 1988]; and The Economic Consequences of Mr.
Recall that in A Tract on Monetary Reform, Keynes had introduced covered interest arbitrage, equating the spread between forward and spot exchange rates to the difference between nominal interest rates in two currencies, if capital is mobile (uncovered interest arbitrage, equating the interest differential to the expected rate of appreciation or depreciation of the exchange rate, had been introduced by Irving Fisher in 1896).
More advanced subjects, such as covered interest arbitrage and hedging alternatives, are presented so that more expert users may sharpen their skills.
The theoretical forward rate may be observed in the currency markets where there are no obvious covered interest arbitrage opportunities.