Suppose the spot rate on the Indian rupee is Rs65.2203,the risk-free nominal rate in the U.S.is 4.6 percent,and the Indian risk-free nominal rate is 6.2 percent.Which one of the following one-year forward rates best establishes the approximate interest rate parity condition?

Question

Quizplus · Accepted Answer

According to Interest Rate Parity (IRP), the one-year forward exchange rate should be such that it eliminates any arbitrage opportunities between the spot exchange rate and the risk-free interest rates in the two countries.

The formula for IRP is:

(1 + r₽ ) = (1 + rf)/(1 + Sf/S)

where, 
r₽  = Indian risk-free nominal rate = 6.2%
rf = U.S. risk-free nominal rate = 4.6%
S = spot exchange rate = Rs65.2203
Sf = one-year forward exchange rate
 
Substituting the given values:

(1 + 0.062) = (1 + 0.046)/(1 + Sf/65.2203)

Solving for Sf, we get:

Sf = Rs66.2638

Therefore, the best choice is B.

Suppose the Spot Rate on the Indian Rupee Is Rs65