Suppose the spot rates for the pound, mark, and Swiss franc are $1.50, $.42, and $.48, respectively. The associated 90?day interest rates (annualized) are 12%, 6%, and 4%, while the U.S. 90?day interest rate (annualized) is 8%. What is the 90?day forward rate on a DCU (DCU 1 = £1 + DM1 + SFr1) if interest parity holds?

Question

Quizplus · Accepted Answer

Using the interest rate parity formula:

(1 + rDCU) = (1 + r£)(1 + rDM)(1 + rSFr)/(F£/DCU)(FDM/DCU)(FSFr/DCU)

Plugging in the given values:

(1 + 0.08) = (1 + 0.12)(1 + 0.06)(1 + 0.04)/(F£/DCU)(FDM/DCU)(FSFr/DCU)

Solving for F£/DCU:

F£/DCU = (£1 + DM1 + SFr1) / (1.50)(1.06)(1.04)(1.08)

F£/DCU = 2.3923

Therefore, the 90-day forward rate on a DCU is $2.3923. Answer choice B is the correct answer.

Suppose the Spot Rates for the Pound, Mark, and Swiss