CFA Level I · CFA Level I Exam · Capital Flows and the FX Market
The spot rate is 1.2500 USD per EUR. The one-year interest rate is 4.0% in USD and 2.0% in EUR. Using covered interest rate parity, the one-year forward rate (USD per EUR) is closest to:
The forward rate is about 1.2745 USD per EUR. Under covered interest parity, multiply the spot rate of 1.2500 by the ratio of USD to EUR gross interest factors, 1.04 divided by 1.02. The higher USD rate means the EUR trades at a forward premium.
- A1.2255
- B1.2745Correct
- C1.3000
Explanation
F = S x (1 + i_USD)/(1 + i_EUR) = 1.2500 x 1.04/1.02 = 1.2500 x 1.019608 = 1.2745. The 1.2255 result comes from inverting the interest ratio, so the forward would wrongly show a discount. The 1.3000 result ignores the EUR rate and uses only the USD rate.
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