IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates
Spot is Rs 80 per dollar. One-year interest rates are 7% in India and 4% in the US. Under covered interest rate parity, what is the one-year forward rate (approximately, to two decimals)?
Covered interest parity sets the forward rate equal to spot times the ratio of domestic to foreign interest factors. That is 80 multiplied by 1.07 and divided by 1.04, giving about Rs 82.31 per dollar. The rupee trades at a forward discount because Indian interest rates are higher.
- ARs 77.67 per dollar
- BRs 80.00 per dollar
- CRs 82.31 per dollarCorrect
- DRs 83.20 per dollar
- Rs 85.60 per dollar
Explanation
Forward = 80 x 1.07 / 1.04 = 82.31. Rs 83.20 results from adding the rate difference of 4% simply to the spot rate, Rs 77.67 inverts the ratio, and Rs 85.60 multiplies by 1.07 ignoring US interest. Higher Indian interest means a forward discount on the rupee.
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