CFA CFA Level 2 Covered Interest Rate Parity Question

Covered Interest Rate Parity Question

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    • GraemeA
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      Good Day All,

      I am having trouble deriving the expression for the forward premium or discount given the covered interest rate parity equation.

      F f/d = S f/d ( 1 + if [Actual/360] / 1 + id [Actual/360]) is the Forward Rate formula. However, I am having trouble re-arranging this to get the forward premium/discount formula, given by:

      F f/d – S f/d = S f/d ( Actual/360 / 1 + id [Actual/360] ) (if – id)

      Can anyone show me the re-arrangement of the formula?

      Thank you

    • edulima
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      Hi @GraemeA, try the following:

      Start with the first formula and subtract S_f/d from both sides. The left-hand side is obvious; in the right-hand side, factor out S_f/d and you are left with a fraction that looks like (for more clarity I omitted the “Actual/360” from the notation):

      (1+if)/(1+id) -1, which equals [(1+if) – (1+id)]/(1+id), which in turn reduces to (if – id)/(1 + id).

      Hope this helps!

    • GraemeA
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      Thank you edulima

    • hairyfairy
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      I should start my revision….. 🙁

    • akansha_singh83
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      Although it is quite late to say this but thank you edulima……. I had been trying to figure this out for sometime. 🙂

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