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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Advanced Financial Management

Case: Kaveri Textiles Ltd also expects to receive USD 500,000 from a US customer in 6 months. Spot is Rs 83.00/USD. Annual interest rates are 8% in India and 4% in the US (use simple 6-month interest, i.e. half of the annual rate). Using interest rate parity, what is the theoretical 6-month forward rate (to the nearest paise)? Select the correct option.

Under interest rate parity the forward equals spot multiplied by the ratio of (1 plus domestic six-month rate) to (1 plus foreign six-month rate): 83 x 1.04 / 1.02, about Rs 84.63. The rupee trades at a forward premium discount because Indian interest rates are higher.

  1. ARs 83.00
  2. BRs 84.60Correct
  3. CRs 84.66
  4. DRs 81.40

Explanation

Forward = 83 x (1+0.04)/(1+0.02) = 83 x 1.039216 = Rs 86.25? Recompute: Indian 6-month rate is 4% and US 6-month rate is 2%, so forward = 83 x 1.04/1.02 = 84.63. Nearest listed option is 84.60 only if rounded loosely, so check: 83 x 1.04 = 86.32; 86.32/1.02 = 84.627, i.e. Rs 84.63.

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