Question

Suppose the one-year forward $/€ exchange rate is $1.26 per euro and the spot exchange rate is $1.20 per euro. What is the forward premium on euros (the forward discount on dollars)? What is the difference between the interest rate on one-year dollar deposits and that on one-year euro deposits (assuming no repayment risk)?

Answer 1

Answer:

A.5$

B.The difference between the interest rate on one-year dollar deposits and that on one-year euro deposits (assuming no repayment risk) is 5%

Explanation:

A.

The forward premium on euro is (1.26 - 1.20)/1.20 = 0.05 or 5%

B. The interest rate difference between one-year dollar deposits and one-year euro deposits (assuming no repayment risk) will be 5 percent because the interest difference must equal the forward premium on euro against dollars when the covered interest parity holds.