Uncovered interest arbitrage

So imagine you have two piggy banks, one in your room and one at your friend's house. The piggy bank in your room has $100 in it, but the piggy bank at your friend's house has $105 in it.

Now, you want to make some money and you notice that the bank at your friend's house is offering a much higher interest rate of 5%, while your piggy bank is only offering 2%.

Uncovered interest arbitrage is a way to make money by borrowing money from your piggy bank at a lower interest rate (2%) and then investing that money in your friend's piggy bank at a higher interest rate (5%).

So you ask your mom for permission to borrow $100 from your piggy bank, and you promise to pay her back with interest. She agrees and you take the $100 and put it into your friend's piggy bank, where it will earn interest at a higher rate.

Over time, the money in your friend's piggy bank will grow, and eventually you will have earned more interest than you had to pay back to your mom for borrowing the $100. This means you've made a profit, just by taking advantage of the difference in interest rates between the two piggy banks.

Uncovered interest arbitrage is often used in the real world by banks and investors to make money, but it can be a little more complicated than just borrowing from one piggy bank and investing in another. It involves dealing with different currencies, interest rates, and economic conditions in different countries, but the basic idea is the same – you're taking advantage of a difference in interest rates to make a profit.