Task 3 Assume that the rates shown in the table below accurately reflect current

Question

Task 3 Assume that the rates shown in the table below accurately reflect current conditions in the financial markets Dollar/Euro Spot Rate Dollar/Euro 1-Year Forward Rate 1-Year Deposit Rate: Euro U.S 1.21 1.18 3% In the table, the one-year forward dollar-euro exchange rate is mispriced, because it doesn't reflect the interest rate differentials between the United States and Europe. A. Calculate the amount of the current forward exchange discount or premium B. Calculate the value that the forward rate would need to be in order to keep riskless arbitrage from occurring

Explanation / Answer

A. Forward exchange discount of Euro = (Forward rate - Spot rate) / Spot rate = (1.18 - 1.21) / 1.21 = -2.479%

The minus sign indicates that the Euro is at discount.

B. Required Forward rate shall be computed as follows:

Euro 1 * (1+0.03) = USD 1.21 * (1+0.02)

Euro 1.03 = USD 1.2342

Euro 1 = USD 1.1983

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