Question

If annualized nominal interest rates in the US and Switzerland are 12% and 8% respectively and the 90-day forward [one-year forward] rate for the Swiss franc is $1.0218, at what current spot rate for the Swiss frank will interest rate parity hold?

Answer 1

According to interest rate parity theory forward rate differential is equal to interest rate differential between two countries.

IF -S/S] *360/n = {(1 + ra)/(1+r) - 1

By solving this equation we get the formula to calculate spot rate

S = F/[((1+ra)/(1+rb)-1)*n/360+1]

Where

Forward rate = $ 1.0218 per swiss franc

Interest rate (ra) in USA = 0.12

Interest rate in Switzerland (rb) = 0.08

n = Number of months

By putting all the values in the equation

we get S = $ 1.0124 per swiss franc