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Country G and Country H have currencies that trade freely and have markets for forward currency contracts. If Country G has a

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Answer #1

The answer is A, "Greater than the G/H spot rate"

Let currency of country 1 as US dollar and country 2 as Yen

1 Dollar = 100 Yen

Spot exchange rate = USD/ JPY = 100

Interest rate in US = 2%

Interest rate in Japan = 0%

Forward 1 year interest in US = 2 % of 1 dollar = 0.02 + 1 = 1.02

Forward 1 year rate of Yen = 0% of 100 = 100

Therefore forward 1 Year rate = USD / JPY = 100 * 1.02 = 102 Yen

Here now the forward 1 year rate as per interest rate differntial is USD/ JPY = 102

This reflect that forward rate is trading at premium. Forward premium is the condition in which forward rate of currency is greater than spot price.

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