You know from your international finance course that in theory, there should be a parity...
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You know from your international finance course that in theory, there should be a parity in the foreign exchange rates and interest rates. If not, then there would be an arbitrage opportunity. One day you scrutinize the rates for Malaysia and Brunei as reported in the newspaper and suspect that the parity may not hold. Here are the rates you observe: BNDO.50/MYR BND0.45/MYR Spot exchange rate: 3-month forward rate: Malaysian interest rate: Brunei interest rate: 6.4% p.a. 4.0% p.a. i. Does interest rate parity (IRP) hold above? Analyze how you determine the answer [3 marks] ii. If IRP does not hold, explain your strategy to profit from covered interest arbitrage, assuming that you can borrow MYR100,000 or BND50,000. Determine the arbitrage profit in MYR you may get. [4 marks] iii. In an efficient market, predict the movement of the exchange rates and interest rates due to the above situation. [2 marks]
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