Jake Tan a foreign exchange trader at ComSec(Malaysia), is exploring covered interest arbitrage possibilities. He is seeking to gain benefits on covered interest arbitrage in investing either AUD50,000 or MYR250,000. He has been offered the following exchange rate and interest rate quotes (not annualised).

Spot rate MYR3.1192/AUD 180-day forward rate MYR3.1052/AUD 180-day Australian dollar interest rate 2.8% 180-day Malaysian ringgit (MYR) interest rate 1.4%

Required:

Briefly explain the difference between interest rate parity theory (IRP) and the International Fisher Effect (IFE). Using the given information, estimate the market forward premium or discount for AUD. Estimate the forward premium or discount for AUD (interest rate differential) using the interest rate parity theory (IRP). Does IRP hold? Explain (use your answer to part 2 and 3 to justify your answer). Are there any covered interest rate arbitrage opportunity (use IRP condition to prove your answer). Illustrate how such opportunity can be capitalised (Note: Mr. Tan can borrow either AUD50,000 or MYR250,000 for the arbitrage).