12. Assume that interest rate parity holds and that 90- dayrisk free securities

Question

12. Assume that interest rate parity holds and that 90- dayrisk free securities yield 5% in the US and 5.3% in Germany. In the spot market, 1 euro equals$1.40. What is the 90- day forward rate? Is the 90- day forward rate trading at a premium or a discounnt relative to the spot rate? 12. Assume that interest rate parity holds and that 90- dayrisk free securities yield 5% in the US and 5.3% in Germany. In the spot market, 1 euro equals$1.40. What is the 90- day forward rate? Is the 90- day forward rate trading at a premium or a discounnt relative to the spot rate?

Explanation / Answer

Forward Rate = Spot Rate X (1 + Interest Rate of Overseas country)
                                             (1 + Interest Rate of Domestic country)

                    =1.4*(1+5%)/((1+5.3%)

Forward Rate =1.396

i.e 1euro equals $1.396

Thus 90 Day forward rate is at discount to spot rate.

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