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Hello John,
2014, December, question 3b
I don’t understand how the examiner arrived at 4.3132 in calculating the implied annual interest rate of the overseas country
I am not sure which bit of the answer you are not clear about.
The interest rate parity formula gives the forward rate when the know the relative interest rates and the spot rate.
In this question, we know the spot rate, we know the forward rate, we know the interest rate in PZK’s country, and so we can use the formula to calculate what the interest rate must be in the other country.
I understand everything you said and using the formula. What I don’t understand is the math behind finding the unknown numerator.
Fo = So x (1 + ic) / (1 + ib)
So 4.3132 = 4.2080 x (1 + ic) / 1.04
Multiply both sides by 1.04:
4.3132 x 1.04 = 4.2080 x (1 + ic)
Divide both sides by 4.2080″
(4.3132 x 1.04) / 4.2080 = 1 + ic
1.066 = 1 + ic
Subtract 1 from both sides:
0.066 = ic (or ic = 6.6%)
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