Quiz question Forward Rate

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November 30, 2014 at 11:14 am #214697
Stefano
Member
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Hi,

Would you mind helping me with this question?

The current spot rate of the US $ against the £ is $/£ 1.8420
Interest in the US is 5% per year. Interest in the UK is 4% per year.
what would you expect the three month forward rate to be?

the answer is $/£ 1.8466 (I need to understand the calculation to get to this answer)

Thank you in advance,

SP
November 30, 2014 at 3:20 pm #214758
John Moffat
Keymaster
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The three month interest rates are:
US 5 x 3/12 = 1.25%
UK 4 x 3/12 = 1%

Using the interest rate parity formula,
the forward rate in 3 months = 1.8466 x 1.0125/1.01 = 1.8512
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