Q1 Investing interest rates in Thailand are 2.5% p.a. and in Hungary they are currently at 8.25% p.a. The THB/HUF spot rate is 10.02

(a) Assume no transaction costs. Calculate the theoretical three-year forward rate of the THB implied by Interest Rate Parity.

(b) Now assume the actual three-year forward rate is THB/HUF 11.41. What, if any, is the percentage return from engaging in Covered Interest Arbitrage? Assume a transaction cost of 0.2% in the spot and the forward market. Also assume that borrowing rates are 0.75% higher than the investing rates in both countries.

Your answer will be either (choose the appropriate one):

A. Arbitrage: Calculate the result as a percentage of your initial borrowing, accurate to 4 decimal places, making sure to include any opportunity costs in your calculations).

B. No arbitrage: If there is no arbitrage available then show how you are unable to make money through a covered interest arbitrage process.