CFA Level I · CFA Level I Exam · Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities
The spot exchange rate is 1.2500 USD/EUR. The one-year interest rate is 4.00% in USD and 2.00% in EUR, both annually compounded. The one-year forward rate (USD/EUR) implied by covered interest rate parity is closest to:
The forward rate is about 1.2745 USD/EUR. Covered interest rate parity gives 1.2500 multiplied by 1.04 over 1.02, which is 1.2745. The higher USD rate means the euro trades at a forward premium against the dollar.
- A1.2255
- B1.2500
- C1.2745Correct
Explanation
F = 1.2500 x 1.04/1.02 = 1.2500 x 1.019608 = 1.2745. The 1.2255 option inverts the ratio of interest rates (1.02/1.04). The 1.2500 option ignores the interest rate differential.
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