US CMA Part 2 · Chapter 4 · Question 14 of 15
The spot exchange rate is $1.10 per euro. One-year interest rates are 5% in the United States and 3% in the eurozone. According to interest rate parity, what should the one-year forward rate be (rounded to four decimals)?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: D) $1.1214 per euro
Explanation
Interest rate parity: forward ($/euro) = spot x (1 + US rate) / (1 + euro rate) = 1.10 x 1.05 / 1.03 = 1.1214. The currency with the higher interest rate (the dollar) trades at a forward discount, so more dollars are needed per euro in the forward market. Inverting the interest rates gives 1.0790.
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