Question

If annualized interest rates in the U.S. and Switzerland are 10% and 4%, respectively, and the 90 day forward rate for the Swiss franc is $.3864, at what current spot rate will interest rate parity hold

Answer 1

Answer:

 Spot rate = 0.3807

Explanation:

Given:

Interest rates in the U.S. = 10% = 0.1

Interest rates in Switzerland  = 4% = 0.04

Forward rate = $0.3864

Spot rate = ?

Day ratio = 90 days / 360 days = 0.25 (Assume 360 days in a year)

Computation of Spot rate:

Spot rate = Forward rate[1+(Domestic rate × Day ratio)] / [1+ (Foreign rate × Day ratio)]

Spot rate = 0.3864[1+(0.04 × 0.25)] / [1+(0.10 × 0.25)]

 Spot rate = 0.3864[1+0.01] / [1+0.025]

 Spot rate = 0.3864[1.01] / [1.025]

 Spot rate = 0.390264 / [1.025]

 Spot rate = 0.3807