# interest rate parity question

I would appreciate if somebody can help me with this problem: This is one of the problems from the Schweser note (Assigned reading 18 question 10) Question: Assume the Phillipine peso is at a 1 year forward discount of 1.25% to the Thai baht, and Thailand`s 1 year interest rate is at 3%. If a Thai investor has no arbitrage opportunities, the Phillipine interest rate is closest to: A, 4.25%. B, 1.76% C, 1.25% Answer:If there are no arbitrage opportuniites, IRP holds, and the interest rate differentila is equal to the forward differential ( i understand this).Since the PHP is trading at a forward discount, PHP interest rate must be greater than THB interest rate. Thanks

Thai Baht f = -1.25% Thai I = 3% f = Thai I - Philline I or -1.25 = 3 - X solve for X: X = 3 - (-1.25) = 3 + 1.25 or 4.25% since the PHP is a discount, f is a negative #. Does that answer your Q?

Not really, i guess i am a little slow on this!

Forward discount = 1.25% means (F - S) / S = -1.25% or rearrange above gives you: F / S = 98.75% (100% - 1.25%) obviously because this is a discount, this % should be < 100%… if premium, then this # would be 101.25%. Remember your formula: F / S = (1 + Rc) / (1 + Rb) Where F and S quoted as Base:Counter (peso to baht, so peso = base) Rc = interest rate of “counter” Rb = interest rate of “base” so 98.75% = (1+3%) / (1 + Rb) Rb = 4.30% the above was the EXACT calculation. The approximation is the following: forward differential = interest rate differential -1.25% = Rcounter - Rbase (once again Rcounter is baht because we’re given "peso to bach, i.e., Peso:Baht) -1.25% = 3% - Rbase Rbase = 4.25%

Thanks a lot!If you are in midtown I get you a beer! I think its awsome you post something and somebody answers it in a day!