Please answer all the questions and not just one or two. (a) Based on covered in
ID: 2724532 • Letter: P
Question
Please answer all the questions and not just one or two.
(a) Based on covered interest rate parity, calculate corresponding, one-month forward NOK/EUR rates as of 01 June, 01 July, 01 August, and 01 September.
(b) Having calculated one-month forward rates, does it appear an unbiased predictor of the future spot rate for the months of July, August, and September? Briefly explain!
(c) Derive the expression for the uncovered interest rate parity! How does it differ from covered interest rate parity?
The data provided in the table are supposed to be used when answering the questions below. The interest rates are risk-free. Month Date Spot rate NOK interest rate p.a EUR interest rate p.a 01 Jun 01 Jul 01 Aug 01 SepNOK 8.0060 NOK 8.0000 NOK 8.0020 NOK 8.0040 2.30% 2.15% 2.00% 1 .90% 2.00% 1.85% 1 . 70% 1 .90%Explanation / Answer
Solution:
To compute the forward rate NOK/EUR we need to find out using the interest rate parity :
Interest rate parity formula = Forward rate F.C = spot rate (1+ Interest home /1+ Interest rate foreign )
01 june = 8 *( 1.02/12/1.023/12) =6.956
01 july = 8.0020 *(1.0185/12/1.0215/12) = 6.885
01 august = 8.0040*(1.017/12/1.02/12) = 6.803
01 september = 8.0060 *1.019/12/1.019/12 = 8.0060
Solution b) :
There is an unbiased predictor of the future as we can see that upto the august month forward rate there was a pattern and it was in sync with the spot rate and interest rate but in the month of september suddenly the forward rate becomes equal to the spot rate.
Since Uncovered IRP is not bound by arbitrage, in another word, you cann’t trade based on this relationship, so it can give you an expected exchange rate E(S), which may not hold. The Cover IRP is traded on the relationship of the interest rates, so it has to be arbitrage free and calculates the forword rate F(t).