As of today, the spot exchange rate is €1.00 = $1.60 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

We can use the formula for calculating the forward rate:
Forward rate = Spot rate x (1 + domestic interest rate) / (1 + foreign interest rate)
Here, domestic interest rate (in the euro zone) = 3% and foreign interest rate (in the U.S.) = 2%
Forward rate = €1.00 x (1 + 0.03) / (1 + 0.02) = €1.00 x 1.03 / 1.02 = €1.0303 / 1.02 = €1.0098
Converting this to dollars using the spot exchange rate:
Forward rate = €1.00 = $1.5845 (rounded to four decimal places)

Therefore, the best choice is C.

As of Today, the Spot Exchange Rate Is €1