Suppose you observe a spot exchange rate of $2.00/£. If interest rates are 5 percent per annum in the U.S. and 2 percent per annum in the U.K., what is the no-arbitrage one-year forward rate?Group of answer choices£1.9429/$$1.9429/££2.0588/$$2.0588/£
Question
Suppose you observe a spot exchange rate of $2.0588/£
Solution
The no-arbitrage one-year forward rate can be calculated using the formula:
F = S * (1 + i_d) / (1 + i_f)
where: F is the forward rate S is the spot rate i_d is the interest rate in the domestic country i_f is the interest rate in the foreign country
Given: S = $2.00/£ i_d (US interest rate) = 5% or 0.05 i_f (UK interest rate) = 2% or 0.02
Substituting these values into the formula, we get:
F = 2 * (1 + 0.05) / (1 + 0.02)
Solving this gives:
F = 2.0588 $/£
So, the no-arbitrage one-year forward rate is $2.0588/£.
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