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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

INTEREST RATE PARITY Assume that interest rate parity holds and that 90-day risk-free securities yield a nominal annual rate of 3% in the United States and a nominal annual rate of 3 5% in the United Kingdom. In the spot market, 1 pound = $1 67.

  1. a. What is the 90-day forward rate?
  2. b. Is the 90-day forward rate trading at a premium or a discount relative to the spot rate?

a.

Summary Introduction

To determine: The 90-day forward rate.

Introduction:

Interest rate parity: Interest rate parity is the theory which is utilised to show the relationship between the future rate and the spot rate of the two country currency.

Explanation

Determine the 90-day forward rate

Given,

Spot price is $1.67.

Risk free security is 3% or 0.75% (3%/4).

Nominal rate is 3.5% or 0.875% (3.5%/4).

ForwardRateSpotExchangeRate=1+ExchangeRate1+RiskfreeRateForwardRate$1

b.

Summary Introduction

To determine: Whether the forward rate is at premium or discount related to spot rate.

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