Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany,and the one-year forward exchange rate is $1.16/€.What must the spot exchange rate be?
A)$1.1768/€
B)$1.1434/€
C)$1.12/€
D)none of the options

Question

Quizplus · Accepted Answer

To find the spot exchange rate, we need to apply the interest rate parity formula:
(1 + US interest rate) = (1 + German interest rate) x (forward exchange rate / spot exchange rate)
Substituting the given values:
(1.05) = (1.035) x (1.16 / spot exchange rate)
Solving for the spot exchange rate:
spot exchange rate = 1.1434/€ (rounded to four decimal places)

Suppose That the One-Year Interest Rate Is 5