The spot $US/euro exchange rate is $US1.3549/euro. The three-month forward rate is $US1.3595/euro. What is the euro's forward premium (or discount)on the U.S. dollar, expressed as an annual percentage?
A)0.3 percent premium
B)0.3 percent discount
C)1.4 percent premium
D)1.4 percent discount

Question

Quizplus · Accepted Answer

To calculate the forward premium or discount on the US dollar, we need to compare the forward rate with the spot rate and calculate the difference as a percentage.

Forward premium/discount = [(Forward rate - Spot rate)/Spot rate] x (12/number of months)

Here, the spot rate is $US1.3549/euro, and the three-month forward rate is $US1.3595/euro.

Forward premium/discount = [(1.3595 - 1.3549)/1.3549] x (12/3)
                      = (0.0046/1.3549) x 4
                      = 0.0135 or 1.35%

Since the forward rate is higher than the spot rate, the euro is trading at a premium against the US dollar. Therefore, the correct answer is 1.4 percent premium (Option C).

The Spot $US/euro Exchange Rate Is $US1