If annualized interest rates in the U.S. and France are 9% and 13%, respectively, and the spot value of the franc is $.1109, then at what 180?day forward rate will interest rate parity hold?

Question

Quizplus · Accepted Answer

According to interest rate parity, the percentage difference in interest rates between two countries should be equal to the percentage difference in their forward exchange rates. Let F be the forward rate, then:

(1 + 0.09)^0.5 = (1 + 0.13)^0.5 x (1 + F)

Solving for F:

F = (1 + 0.09)^0.5 / (1 + 0.13)^0.5 - 1
  = 0.0429

Therefore, the 180-day forward rate is:

$.1109 x (1 + 0.0429) = $.1150

The closest answer choice is C, $.1088 is different from the calculated one, and the other two options are way off from the calculated value.

If Annualized Interest Rates in the U