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FRM Part I · FRM Exam Part I · Foreign Exchange Markets

The spot EUR/USD rate is 1.1000 (USD per EUR). The one-year USD interest rate is 5% and the one-year EUR interest rate is 3%, both annually compounded. Under covered interest rate parity, what is the one-year forward EUR/USD rate (rounded to four decimals)?

The forward rate is 1.1214 USD per EUR. Covered interest parity requires the forward to equal spot times the ratio of one plus the USD rate to one plus the EUR rate, so 1.1000 × 1.05/1.03 gives 1.1214. The EUR trades at a forward premium because its interest rate is lower.

  1. A1.0795
  2. B1.1000
  3. C1.1214Correct
  4. D1.1550

Explanation

F = S × (1 + r_USD)/(1 + r_EUR) = 1.1000 × 1.05/1.03 = 1.1000 × 1.019417 = 1.1214. Option 1.0795 inverts the ratio, using the foreign rate over the domestic rate. Option 1.1550 multiplies spot by 1.05 and ignores the EUR rate.

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