1. The 1-year interest rate in the U.S. is 10%; in Switzerland it is 12%. The cu

Question

1. The 1-year interest rate in the U.S. is 10%; in Switzerland it is 12%. The current spot rate (dollars per franc) is $0.40.

a.         What do you expect the 1-year forward rate to be ?

b.         Is the franc selling at a premium or discount?   

c.          If the expected spot rate in 1 year is $0.38, what is the risk premium?

2. The Swiss franc is selling in the spot market for $0.60, while in the 90-day forward market it sells for $ 0.62.

a.         Is the dollar selling at a premium or discount?

b.         What is the forward premium (discount) on the franc (at an annual rate)?

Explanation / Answer

1. a.As per nterest rate parity:

$.40[(1 + .10)/(1 + .12)] = $0.392857

b. Since, the forward rate is less than the spot rate franc is selling at forward discount.

c.Forward discount = Forward rate - spot rate/ Spot rate = 0.39-0.40/0.40 = -1.78%

2. a. Spot rate = $0.60,

90-day forward rate = $ 0.62.

Since, the forward rate is lmore than the spot rate franc is selling at forward premium.

b.Forward premium = Forward rate - spot rate/ Spot rate = 0.62-0.60/0.60 = 3.33%

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