Suppose that the spot price of the euro is currently $1.30. The 1-year futures price is $1.35. Is the interest rate higher in the United States or the euro zone?

The interest rate is higher in the US.

Explanation:

The forward price is calculated using the following formula,

F = S (1+Rd / 1+Rf) ^t

where,

F = Forward rate S = Spot rate Rd = Nominal interest rate in domestic market Rf = Nominal interest rate in foreign market t = time in years

We consider that the domestic market is the US and the domestic currency is the USD. Thus, it is a direct quote where 1 EUR = 1.3 USD

The forward price ER is more than the Sport ER only when the interest rate in domestic market is more than the interest rate in foreign market and as a result, the value of domestic currency against a foreign currency in the forward market depreciates.

We can see this by the following example,

Say Spot rate is $1.3 per 1 EUR and the interest rate in US is 10% while that in Euro zone is 5%. When we calculate the forward ER we will see that 1 EUR will buy us more USD in forward (more than 1.3 USD)

F = 1.3 * (1.1 / 1.05) ^1 = > $1.362 PER 1EUR