Suppose the interest on a foreign government bonds is 7.5%, and the current exchange rate is 28 foreign currencies per dollar. If the forward exchange rate is 28.5 foreign currencies per dollar, and the current US risk-free rate is 4.5%, what is the implied risk premium of the foreign government bond

implied credit spread = 1.13 %

Explanation:

given data

interest on foreign government bonds = 7.5%

current exchange rate = 28

forward exchange rate = 28.5

risk-free rate = 4.5%

solution

we get here risk free rate by the forward exchange rate that is

F = spot exchange rate * / frac{1+Rr}{1+Rs} ... 1

put here value

28.5 = 28 * / frac{1+Rr}{1+0.045}

solve it we get

Rr = 0.0637

Rr = 6.37%

so

implied credit spread = interest on foreign government bonds - risk free rate

implied credit spread = 7.5% - 6.37%

implied credit spread = 1.13 %