14-84 What should be the one-year forward rate in order to prevent any arbitrage?
A)$0.1944/€.
B)$0.1975/€.
C)$0.2000/€.
D)$0.2025/€.
E)$0.2031/€.

Question

Quizplus · Accepted Answer

The one-year forward rate should be $0.1944/€ to prevent any arbitrage. This is because the current spot rate is $1.20/€ and the one-year risk-free rate in the US is 4%, while the one-year risk-free rate in the eurozone is 2%. If the one-year forward rate were any higher than $0.1944/€, then it would be possible to make a risk-free profit by borrowing euros at 2%, converting them to dollars at the spot rate, investing the dollars at 4%, and then selling the dollars forward at the higher forward rate.

14-84 What Should Be the One-Year Forward Rate in Order