Question
Asked Mar 10, 2020
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Suppose that the spot price of the euro is currently $1.10. The 1-year futures price is $1.15. Is the interest rate higher in the United States or the euro zone?

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Expert Answer

Step 1

The question is based on the relation between exchange rate and interest rate differential between countries. The relationship explains in form of Interest rate parity (IRP) and forward exchange rate .

Step 2

The spot price of the euro is currently $1.10 and the 1-year futures price is $1.15. The relation of future exchange rate, spot rate and interest rate can be explained by

Finance homework question answer, step 2, image 1

Case 1: if interest rate in Euro (re )= interest rate in Dollar (r$ ) , then Future rate(Ft) = Spot rate(St) at time (t) of 1 year

Case 2: if interest rate in Euro (re )> interest rate in Dollar (r$ ) , then Future rate(Ft) > Spot rate(St) time (t) of 1 year

Case 3:  if interest rate in Euro (re)< interest rate in Dollar (r$) , then Future rate(Ft) < Spot rate(St) time...

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