ACCA Strategic Professional · Advanced Financial Management · Management of international trade and finance
Under interest rate parity, the spot rate is EUR/USD 0.9000 (EUR per USD 1), annual interest rates are 5% in the euro and 3% in the dollar. What is the one-year forward rate (EUR per USD)?
The one-year forward rate is 0.9175 euro per dollar. Interest rate parity multiplies the spot rate by the ratio of euro to dollar interest factors, 1.05 over 1.03. The euro, with higher interest, trades at a forward discount, so more euros are needed per dollar.
- A0.9175Correct
- B0.8826
- C0.9000
- D0.9257
Explanation
Forward = spot x (1 + i EUR)/(1 + i USD) = 0.9000 x 1.05/1.03 = 0.9175. Inverting the ratio gives 0.8826, which is wrong because the higher-interest currency (EUR) should be weaker forward, meaning more EUR per USD.
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