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22 May, 18:59

The current USD/euro exchange rate is 1.4000 dollar per euro. The six month forward exchange rate is 1.3950. The six month USD interest rate is 1% per annum continuously compounded. Estimate the six month euro interest rate. If the six-month euro interest rate is rf th

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  1. 22 May, 19:24
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    the six month euro interest rate is 1.36%

    Explanation:

    Spot exchange rate: 1.4 USD / EUR

    6 month forward rate: 1.3950 USD/EUR

    Domestic interest rate: 1% pa

    Foreign interest rate: the six month euro interest rate?

    We have the formula:

    Forward rates = Spot rate * (1+domestic interest rate) / (1+foreign interest rate)

    ⇔ 1.3950 = 1.4 * (1+1%) / (1+foreign interest rate)

    ⇔ 1+foreign interest rate = 1.4 * (1+1%) / 1.3950

    ⇔foreign interest rate = 1.01362 - 1 = 0.01362

    ⇒ the six month euro interest rate is 1.36%
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