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

The spot rate is USD 1.2000 per EUR. The three-month USD interest rate is 4% per year and the EUR rate is 2% per year, both continuously compounded. What is the theoretical three-month forward (futures) price in USD per EUR, to four decimals?

The theoretical forward price is about USD 1.2060 per EUR. Under covered interest parity, the forward equals spot times e raised to the domestic minus foreign rate times time, or 1.2 × e^0.005. Because USD rates exceed EUR rates, the euro trades at a forward premium.

  1. A1.2060Correct
  2. B1.1940
  3. C1.2000
  4. D1.2362

Explanation

F = S e^{(r_d - r_f)T} = 1.2000 × e^{0.02×0.25} = 1.2000 × e^{0.005} = 1.2000 × 1.005013 = 1.2060. The 1.1940 option reverses the rate differential sign. 1.2362 uses the full year instead of three months.

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