What is covered interest arbitrage?
Key takeaways
Covered interest arbitrage is an investment strategy that profits from interest rate differences between two countries by buying and selling foreign currencies while using forward contracts to limit exchange rate risk.
Unlike uncovered interest arbitrage which doesn't hedge risk, covered interest arbitrage is widely considered a relatively risk-free strategy that uses forward contracts to protect against exchange rate fluctuations.
Despite being a low-risk strategy, covered interest arbitrage typically generates small returns as opportunities are infrequent and making large profits requires buying and selling in bulk, which exposes investors to greater potential losses.
Covered interest arbitrage is an investment strategy designed to profit from the differences in interest rates between two countries, when buying and selling foreign currencies.
It involves using a forward contract to limit exposure to exchange rate risk.
Where have you heard about covered interest arbitrage?
There are several arbitrage strategies investors can explore including covered interest arbitrage and uncovered interest arbitrage, which works in a similar way, but doesn’t hedge the risk.
It’s likely investors will have come across these strategies as they’re widely considered to return relatively risk free profit.
What you need to know about covered interest arbitrage…
Although covered interest arbitrage is a low-risk strategy you may find it difficult to make a large profit. Opportunities are infrequent and unless you buy and sell in bulk, exposing yourself to a greater loss, returns are likely to be small.