Step 1: Determine whether an arbitrage opportunity exists.

• We can arrange the formula for covered interest rate parity (CIP) to look like: (1 + r_domestic) − [((1 + r_foreign) × Forward_DC/FC) / Spot_DC/FC] = 0
• If this condition holds with the financial data above, there are no arbitrage opportunities: (1 + 0.06500) − [((1 + 0.05200) × 31.5000) / 30.73000] = 1.06500 − 1.07836 = -0.01336
• Since the no arbitrage condition does not hold, we move on to:

Step 2: Borrow Domestic or Foreign?

• Rule 1: If the sign on the result of Step 1 is negative, borrow domestic. If the sign is positive, borrow foreign. Here, the sign is negative, so borrow domestic.
• Rule 2: See table below. (Rule 2 is an alternative to Rule 1).

(rd − rf) < (Forward − Spot) / Spot	Borrow Domestic
(rd − rf) > (Forward − Spot) / Spot	Borrow Foreign

Here, (0.06500 – 0.05200) compared to (31.5000 – 30.73000) / 30.73000 0.013000 < 0.02506, borrow domestic.

Step 3: Conduct Arbitrage and Calculate Profits.

Step	Description	Rate	Calculation	Result
a	Borrow Domestic		MUR 1,000,000	MUR 1,000,000
b	Exchange MUR for $	Spot	= MUR 1,000,000 / 30.73000 MUR/$	$32,541
c	Lend $ at Foreign (U.S.) Rate		= $32,541 × (1.05200)	$34,233
d	Contract to sell proceeds fwd1	Fwd	= $34,233 × 31.50000 MUR/$	MUR 1,078,340
e	Calculate loan payoff2		= MUR 1,000,000 × (1.06500)	MUR 1,065,000
f	Calculate profit (d-e)			MUR 13,340

Note: ¹ This is the amount you will have available to repay the loan. ² This is the amount you need to repay.