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Sally Franklin is a financial advisor to Jamie Curtess, a U.S. citizen interested in learning more...

Sally Franklin is a financial advisor to Jamie Curtess, a U.S. citizen interested in learning more about how her investments will be affected by exchange rates and differences in interest rates internationally. Franklin has gathered the following information based on Curtess’s investment interests.

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The current spot exchange rate: $1 = €0.74.

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Europe United States

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Nominal 1-year interest rate: 4% ?

Expected annual inflation: 2% 1%

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Franklin also gathers the following information:

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Switzerland South Africa

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Nominal 1-year interest rate: 5%   7%

Expected annual inflation: 3%   5%

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For this question only, assume that the U.S. interest rate is 3.5%. What should the 1-year forward rate be?

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Answer #1

Answer :

Forward exchange rate =spot rate *(1+forieng real interest  rate) /(1+ domestic real interest  rate )

Spot rate=0.74/$

Domestic Real interest rate=4%-2%=2%

Foriegn real interest rate =3.5%-1%=2.5%

So forward rate =0.74*(1+2.5%/)(1+2%)=0.7436/ $

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