Let F_t be the forward rate,S_t be the spot exchange rate,and S^e_t+₁ be the expected future spot rate.Which of the following expressions represents the risk premium?

Question

Quizplus · Accepted Answer

The expected future spot rate represents the market's expectation of where the spot exchange rate will be in the future. The forward rate represents the price agreed upon today for a transaction that will occur in the future. The difference between the expected future spot rate and the forward rate is known as the forward premium or discount. Thus, the risk premium can be calculated as the difference between the forward rate and the expected future spot rate, which is: SS1U1P1eS1S1P0S1U1B1t+S1U1B0S1U1B1 - FS1U1B1tS1U1B0. Looking at the answer choices, only option C matches this formula.

Let Ft Be the Forward Rate,St Be the Spot Exchange

Let F_t Be the Forward Rate,S_t Be the Spot Exchange