The one-year forward exchange rate is 40 INR/USD.If the one-year interest rate in the United States is 4% and in India is 7%,what is the spot exchange rate so as to preclude arbitrage?

Question

Quizplus · Accepted Answer

The spot exchange rate can be calculated using the interest rate parity formula, which ensures no arbitrage opportunities. According to the formula: $F = S \times \frac{(1 + i_{domestic})}{(1 + i_{foreign})}$, where $F$ is the forward rate, $S$ is the spot rate, $i_{domestic}$ is the domestic interest rate, and $i_{foreign}$ is the foreign interest rate. Rearranging the formula to solve for $S$, we get $S = F \times \frac{(1 + i_{foreign})}{(1 + i_{domestic})}$. Plugging in the given values: $S = 40 \times \frac{(1 + 0.04)}{(1 + 0.07)} = 40 \times \frac{1.04}{1.07} = 38.88$.

The One-Year Forward Exchange Rate Is 40 INR/USD