The one-year CD rates for financial institutions with AA ratings are 5 percent in the U.S.and 8 percent in France.An AA-rated U.S.financial institution can borrow by issuing CDs or lend by purchasing CDs at these rates in either market.The current spot rate is $0.20/Euro. What should be the one-year forward rate in order to prevent any arbitrage?

Question

Quizplus · Accepted Answer

To prevent arbitrage, the one-year forward rate must equalize the returns of investing in either currency, considering the interest rates. Using the Interest Rate Parity (IRP) formula: Forward Rate = Spot Rate * (1 + Interest Rate Domestic) / (1 + Interest Rate Foreign). Substituting the given values: Forward Rate = 0.20 * (1 + 0.05) / (1 + 0.08) = 0.20 * 1.05 / 1.08 = 0.1944/€.

The One-Year CD Rates for Financial Institutions with AA Ratings