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FRM Part I · FRM Exam Part I · Pricing Financial Forwards and Futures

A currency has a spot rate of USD 1.2000 per unit of foreign currency. The USD continuously compounded rate is 4% and the foreign rate is 1% per year. Which is the fair 1-year forward rate (USD per foreign unit)?

A foreign currency behaves like an asset paying a yield equal to the foreign interest rate, so the forward is spot times e^((domestic minus foreign rate) x T). That gives about 1.2365 USD per unit, higher than spot because the domestic rate exceeds the foreign rate.

  1. A1.1647
  2. B1.2365Correct
  3. C1.2000
  4. D1.2611

Explanation

Foreign currency acts like an asset with yield equal to the foreign rate. F = 1.2 x e^(0.04-0.01) = 1.2 x 1.030455 = 1.2365. Using the sum of rates gives 1.2611; reversing the differential gives 1.1647.

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