As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?

Question

Quizplus · Accepted Answer

The correct answer is A because the forward rate should reflect the expected change in the exchange rate due to inflation. The expected change in the exchange rate is calculated as (1 + inflation rate in the euro zone) / (1 + inflation rate in the U.S.). In this case, the expected change is (1 + 0.03) / (1 + 0.02) = 1.01. Therefore, the one-year forward rate should be €1.00 = $1.25 * 1.01 = $1.2379.

As of Today, the Spot Exchange Rate Is €1