The spot exchange rate is ₹75 / € and the three months forward exchange rate is ₹76.00 / €. The three month interest rate is 8% per annum in India and 5.8% per annum in Germany. Assume that you can borrow as much as ₹75

Determination of Interest Rate Parity (IRP) Given: Spot Exchange Rate (S) = ₹75 / € Three Months Forward Exchange Rate (F) = ₹76 / € Three Month Interest Rate in India (r h ) = 8% p.a. Three Month Interest Rate in Germany (r f ) = 5.8% p.a. Convert Annual Interest Rates to 3-Month Rates: India's 3-month interest rate = 8% / 4 = 2% or 0.02 Germany's 3-month interest rate = 5.8% / 4 = 1.45% or 0.0145 Interest Rate Parity (IRP) Condition: IRP states that the forward premium or discount should be equal to the interest rate differential between two countries. The formula is: (1 + r h ) / (1 + r f ) = F / S Where: r h = Home country interest rate (India) r f = Foreign country interest rate (Germany) F = Forward Exchange Rate S = Spot Exchange Rate Calculate LHS (Interest Rate Ratio): LHS = (1 + 0.02) / (1 + 0.0145) LHS = 1.02 / 1.0145 ≈ 1.005421 Calculate RHS (Forward/Spot Ratio): RHS = 76 / 75 ≈ 1.013333 Comparison: LHS ≈ 1.005421 RHS ≈ 1.013333 Since LHS ≠ RHS (1.005421 ≠ 1.013333), the Interest Rate Parity is not currently holding . This indicates an opportunity for covered interest arbitrage.