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Ques –
Herd Co is based in a country whose currency is the dollar ($). The company expects to receive €1,500,000 in 6
months’ time from Find Co, a foreign customer. The finance director of Herd Co is concerned that the euro (€) may
depreciate against the dollar before the foreign customer makes payment and she is looking at hedging the receipt.
Herd Co has in issue loan notes with a total nominal value of $4m which can be redeemed in 10 years’ time. The
interest paid on the loan notes is at a variable rate linked to LIBOR. The finance director of Herd Co believes that
interest rates may increase in the near future.
The spot exchange rate is €1.543 per $1. The domestic short-term interest rate is 2% per year, while the foreign
short-term interest rate is 5% per year.a) What is the six-month forward exchange rate predicted by interest rate parity?
Please help me in the above question , thanks in advance!
You use the interest rate parity formula that is provided on the formula sheet (the very last formula on the page).
Because the question requires a 6 month forward rate you use the 6 monthly interest rates which are half of the annual interest rates given in the question.
I do illustrate how to use the formula in my free lectures!
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