Ok folks… I had trouble with this one… Im not following how Schweser posted the ans… Given the following information: The forward rate between dollars and pounds is 1.66$/GBP. The current spot rate is 1.543 $/GBP. The UK interest rate is 5.77%. The interest rate in the United States is 5.976%. Assume a U.S. investor can borrow pounds or dollars. What is the covered interest rate differential? A) 0.07661. B) −0.07814. C) 0.6786. D) Covered interest differential is zero.
I get B. 1.05976 = 1.66(1.0577)/1.543 1.05976 = 1.137901491 = -.078141491
Ok Nib… your right… Is this easier than I am making it or what… why is USrate on one side of the eq… and then on the other you have F * UKrate / spot… Why am I not seeing this here??? Thanks
You’re comparing your domestic rate to what you could earn foreign if you converted your dollars to pounds, invested at the UK rate, and converted your pounds back to dollars. I think thats the logic behind the equation.
yeah ok… that makes sense… I was way off then… thanks Niblita
Basically you need the differential between the [domestic rate] and the [foreign interest rate convered into domestic currency]. That differential represents the covered differtial (probably a risk free rate you could earn by circulating the money)