# Base currency

"Assume that the rates shown in the table below accurately reflect current condi- tions in the financial markets.

Dollar/Euro Spot Rate 1.21 Dollar/Euro 1-Year Forward Rate 1.18 1-Year Deposit Rate: Euro 3% U.S. 2%

In the table, the one-year forward dollar/euro exchange rate is mispriced, because it doesn’t reflect the interest rate differentials between the U.S. and Europe.

A Calculate the amount of the current forward exchange discount or premium. B Calculate the value that the forward rate would need to be in order to keep riskless arbitrage from occurring."

Is your question how to calculate these values?

From the problem given, I have a hard time identifying domestic currency. I calculated part A but for B, What do I put in the eqaution as 1+d ( domestic) is my q. In these type of q, from the quote, how do I identify the domestic currency?

is the answer to 1 - Euro trades at a forward discount of -2.47%

answer to 2: ) 1.1983 should have been the correct value as per IRP?

cpk

Answer is given in the book. I was asking about how to determine the domestic currency from the given quote.

1- (forward - spot )/ spot 2- but forward should be : Dollar/ euro spot x (1+int usd ) / (1+int euro) = forward 1.1983 … but the forward rate given is 1.18 so here they are overstating the dollar and understating the euro .

You cannot determine the domestic currency from the given quote. For a US investor, the USD is domestic, and for a French investor the EUR is domestic.

Is there a reason that you need to know which is domestic and which is foreign?

[quote=“Bilal”]

1- (forward - spot )/ spot 2- but forward should be : Dollar/ euro spot x (1+int usd ) / (1+int euro) = forward 1.1983 … but the forward rate given is 1.18 so here they are overstating the dollar and understating the euro .

Exactly. I was not sure what to put in for (1+int usd ) / (1+int euro). Whether USD rate goes in the nominator or Euro. See my confusion now?

what does int usd mean?

this part HAS NOT CHANGED since Level 1.

you do not need to memorize as Rdc / Rfc

just follow what is on the numerator of the quote - USD - so use int USD above.

so 1.21 * 1.02 / 1.03