Hi all, i cant seem to comprehend the answer given for question 11 in reading 28, the answer mentioned interest rate parity and compare the outcome of the trade by comparing a spot conversion result vs. a forward conversion result, can someone help me understand this better? Much appreciated
I’m a first-time Level 3er so please take my response with that in mind.
They are saying that because we assume there is no arbitrage in risk-free interest rates between countries (interest rate parity), and you earned the risk-free rate when the money was in Japan, you should have earned the risk-free rate in euros. No math… use the chart given to answer 2.13%.
The Solution explanation than shows you how you can confirm that. Convert the Yen to euros as if you repatriated on Day 1. Invest at the 6-month risk-free rate of annualized 2.13% for 6 months. Technically, if you do it in that order, there will be a difference between that value and answer 10’s value, so their way of grabbing Answer 10 and dividing out to obtain the rate of return will better show the equality without the complication of rounding errors.