Assume the exchange rate is GBP 1.35/USD, the US risk-free rate is 3.0 percent, and the UK risk-free rate is 6.5 percent. What is the implied one-year forward rate?
A) GBP 1.40/USD
B) GBP 1.35/USD
C) GBP 1.30/USD
D) GBP 1.25/USD
E) GBP 1.20/USD

Question

Quizplus · Accepted Answer

The implied one-year forward rate can be calculated using the interest rate parity formula, which states that the forward rate should adjust so that an investor would earn the same return from investing domestically or abroad when considering exchange rate changes. The formula is F = S * (1 + i_d) / (1 + i_f), where F is the forward rate, S is the spot rate, i_d is the domestic interest rate, and i_f is the foreign interest rate. Plugging in the given values: F = 1.35 * (1 + 0.03) / (1 + 0.065) ≈ 1.40. Therefore, the implied one-year forward rate is GBP 1.40/USD.

Assume the Exchange Rate Is GBP 1