Covered interest differential

[old_akakaraka]

Quick question on currency arbitrage (FI 2 material):
The covered interest differential = (1 + i.dom) - (1 + i.for) * (F / S.0)
i.dom , i.for are domestic and foreign interest rates, F is forward rate, S.0 is spot rate, all expressed in domestic / foreign currency.
So, if the expression above is not zero, arbitrage opportunities exist; if > 0, should you invest in domestic or foreign rate?
Thanks, OA

 

[chrismaths]

If the covered differential is >0, then the domestic rate is > the covered foreign rate, so you can earn a spread by borrowing the foreign currency, converting to domestic at the spot, earning the domestic risk free rate then converting back to foreign using the forward you took out at inception.
I find it easier to just look at the domestic rate compared to the covered foreign rate. After that the rest is more or less common sense.