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Determine the interest rate parity

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Reference no: EM132816559

Suppose that the annual interest rate is 5 percent in Malaysia and 8 percent in Singapore, and the spot exchange rate is RM1.80/S$ and the forward exchange rate, with one year maturity, is RM1.78/S$. Assume that the arbitrageur can borrow up to RM1,000,000 or $555,556, which is equivalent to RM1,000,000 at the current spot exchange rate.

i. Determine whether the interest rate parity is holding or not holding and whether to borrow in RM or S$?

ii. Carry out covered interest arbitrage. Show all the steps and determine the arbitrage profit/loss.

Reference no: EM132816559

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