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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
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 = $1.29.

  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 forward rate for 90 days.

Introduction:

The rate at which the bank exchanges one country’s currency with another country currency at a future date is termed as forward exchange rate. This happens when it enters into a contract of forward contract.

Explanation

Given information:

The yield of 90 days risk free securities in the Country is 3% or 0.03.

The annual nominal rate in the Country U is 3.5% or 0.035.

The spot market rate is for one pound in the Country U is $1.29.

Equation of interest rate parity:

Forwad exchange rateSpot exchange rate=(1+rh)(1+rf)

Where,

  • rh is yield in Country U dollars.
  • rf is yield in ponds.

rf is (0.035×90360)=0.00875 and rh is (0.03×90360)=0

b)

Summary Introduction

To identify: Whether 90-day forward exchange rate indicates exchange at premium or discount in comparison of spot rate.

Introduction:

Spot exchange rate indicates that particular rate to get exchange the currency of foreign country at the current date.

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