Exchange Rate Calculations: practice question
The spot exchange rate is 0.9000 Swiss francs per U.S. dollar. One-year money market rates are 4% for the U.S. dollar and 1% for the Swiss franc. Under covered interest rate parity, the one-year forward rate in Swiss francs per U.S. dollar is closest to:
- 0.9270
- 0.8740
- 0.9360
Show answer and explanation
Correct answer: B
Working: F = S x (1 + i_quote)/(1 + i_base) = 0.9000 x 1.01/1.04 = 0.8740
Explanation: With the franc as the quote currency, the no-arbitrage forward rate is 0.9000 x (1.01/1.04) = 0.8740, so the dollar trades at a forward discount and the franc at a forward premium. A inverts the interest rate ratio, compounding the dollar rate in the numerator. C multiplies the spot by only the dollar rate and ignores the franc rate entirely.
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