Question

Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 3 percent APR in the U.S. and 5 percent APR in the euro zone, what is the no-arbitrage 1-year forward rate?

Answer 1

The 1 year forward rate with no arbitrage would be $1.03/ €

Step-by-step explanation:

GIVEN INFORMATION -

Spot exchange rate ( S ) - $1.0500/€

US interest rate ( u ) = 3%

Euro zone interest rate ( e ) = 5%

For calculating the forward rate ( F ) we can use the following formula -

( 1 + u ) = F / S ( 1 + e )

( 1 + 3% ) = F / 1.0500 ( 1 + 5% )

1.03 = F / 1.0500 x 1.05

F = 1.03 x 1.0500 / 1.05

= 1.0815 / 1.05

= 1.03

Therefore the forward rate is $1.03/ €.