Covered Interest Rate Parity Theory You are a Euro-based investor and you want to buy 25,000 USD forward for delivery in 1 year. Assume that the spot exchange rate is 1.2952 USD/EUR, the interest rate in the US is 3.25% and the interest rate in the Euro zone is 2.3257%. How does the bank set the forward rate? thanks
Based on Covered interest arbitrage (Rd-Rf)= (forward rate-spot rate)/spot rate domestic =euro, foreign dollars where rates are dc/df spot rate is 1.2952 usd/ euro , therefore 0.770815 euro/usd(dc/df) forward dc/fc= spot*(1+rd)/1+rf forward= 0.763914 there will be a discount
agree with florinpop you should you equation for covered interest rate parity which is: (forward dc/fc)/(spot dc/fc) = (1+rd)/(1+rf) (forward dc/fc) = ((spot dc/fc)*(1+rd))/(1+rf) 1.2952 usd/eur ==> spot = 0.7721 eur/usd rd = 2.3257% rf = 3.25% forward eur/usd = (0.7721*1.023257)/1.0325 = 0.7652 (differences due to rounding)
I missed a number in my rate vorte0.770815 instead of 0.77208
ok. thats why there is a small difference between our results, but generally idea is the same.
tks everyone !! -o:)