CFA Level I · CFA Level I Exam · Capital Flows and the FX Market
A currency's forward rate is at a premium to spot. Under covered interest rate parity, this premium most likely indicates that the:
A forward premium on the base currency most likely means the base currency has the lower interest rate than the price currency. Under covered interest rate parity, the forward exceeds spot when the price-currency interest rate is higher, so the interest differential is offset.
- Abase currency has a lower interest rate than the price currencyCorrect
- Bbase currency has a higher interest rate than the price currency
- Cprice currency has a lower inflation rate than the base currency
Explanation
Forward = spot x (1 + i_price)/(1 + i_base). A forward premium on the base currency requires i_price greater than i_base, so the base currency has the lower interest rate. Answer B reverses this relationship.
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