Question

Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound's forward discount or premium?

Answer 1

The pound's forward discount or premium is 3.74%

Step-by-step explanation:

The current spot rate is 1 Pound = $2

The interest rate parity exists, then:

The forward rate:

1 Pound*1.07 = $2*1.11

1.07 Pound = $2.22

1 pound = $2.0748

The Premium in Pound = $2.0748 - $2

= $0.0748

Premium rate = $0.0748/$2*100

= 3.74%

Therefore, The pound's forward discount or premium is 3.74%