# Forward vs. Spot exchange

The no-arbitrage forward exchange rate for a Euro in Yen is less than the spot rate. The interest rate in:

I. The eurozone is less than in Japan

II. Japan is the same as the eurozone

III. Japan is less than the eurozone

Could someone explain the rationale behind this? I believe that the yen is expected to appreciate against the euro, but I am a bit hazy as to why lower rates in Japan would help to strengthen the Yen vs the euro? (the answer is C, by the way) Thanks! P.S. if anyone has a good link for an explanation of no-arbatrage trading opportunities, I would love to see it!

I wrote an article on this that may be helpful: http://financialexamhelp123.com/covered-interest-rate-parity-irp-pricing-currency-forwards/.

We’re told that S¥/€ > F¥/€, so

S¥/€ > F¥/€ = S¥/€ × (1 + r¥)/(1 + r€)

1 > (1 + r¥)/(1 + r€)

1 + r€ > 1 + r¥

r€ > r¥

The answer is C . There is an inverse relationship between Exchange rates and interest rates between two countries . Here the euro in forward market is at discount in exchange rate terms and Japan is higher . So In interest rates terms, Japan will be on lower side than the interest rate in euro .This has been explained above also in the earlier post.

Hope It is clear…

Thank you for the explanations, S2000magician and edupristine.

You’re welcome.

Euro in yen is Yen/Euro. I think that’s the trick here.

Can anyone expand on the difference and interpretation of a forward discount vs premium ?

CFAI and schweser describe it a little differently and I’m trying to wrap my head around the idea.

A currency (more broadly, any commodity) trades at a forward premium if its price in the future is higher than its price today.

A currency (more broadly, any commodity) trades at a forward discount if its price in the future is lower than its price today.

For example, if we’re given a spot rate of GBP/EUR 0.8242 and a forward rate of GBP/EUR 0.8305, then the euro is trading at a forward premium (versus the pound): it costs more pounds to buy a euro in the future than it does today. The corresponding rates for EUR/GBP are 1.2133 (spot) and 1.2041 (forward), so the pound is trading at a forward discount (versus the euro): it costs fewer euro to buy a pound in the future than it does today.