The spot exchange rate today is $1.4544 per If the 1-year Treasury rate is 3.5% and the 1-year European Central Bank rate is 5%, what would you expect the 12-month forward
Exchange rate to be?

Question

The spot exchange rate today is $1.4544 per  If the 1-year Treasury rate is 3.5% and the 1-year European Central Bank rate is 5%, what would you expect the 12-month forward
Exchange rate to be?

Quizplus · Accepted Answer

According to interest rate parity, the forward exchange rate should adjust so that the return on the domestic currency is equal to the return on the foreign currency. Using the formula F=S*(1+rd/1+rf), where F is the forward exchange rate, S is the spot exchange rate, rd is the domestic interest rate, and rf is the foreign interest rate, we can solve for F:

F = 1.4544*(1+0.035/1+0.05) = 1.4336

Therefore, the expected 12-month forward exchange rate is 1.4336. The formula we use in this case is:
Forward Exchange Rate = Spot Exchange Rate x (1 + Domestic Interest Rate) / (1 + Foreign Interest Rate)
Substituting the values, we get:
Forward Exchange Rate = 1.4544 x (1 + 0.035) / (1 + 0.05)
Forward Exchange Rate = 1.4336 (rounded to four decimal places)

The Spot Exchange Rate Today Is $1