The one-year forward exchange rate is Rupees 45/$. If the one-year interest rate in Australia is 5% and in India is 8%, 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: Forward Rate = Spot Rate * (1 + Interest Rate of Domestic Country) / (1 + Interest Rate of Foreign Country). Rearranging to solve for the Spot Rate gives us: Spot Rate = Forward Rate / ((1 + Interest Rate of Domestic Country) / (1 + Interest Rate of Foreign Country)). Plugging in the given values: Spot Rate = 45 / ((1 + 0.08) / (1 + 0.05)) = 45 / (1.08 / 1.05) = 45 / 1.02857 = 43.75.

The One-Year Forward Exchange Rate Is Rupees 45