Q50008 On April 1, 3 months interest rate in the UK

On April 1, 3 months interest rate in the UK £ and US $ are 7.5% and 3.5% per annum respectively. The UK £/US $ spot rate is 0.7570. What would be the forward rate for US $ for delivery on 30th June ?

Solution

According to Interest Rate Parity theory

F/S = 1+ iA / 1+ iB

Where        F       = Forward Rate

S       = Spot Rate

iA      = £ Interest Rate for 3 months

= 7.5% P.A i.e 1.875% for 3 months

iB       = $ Interest Rate for 3 months

= 3.5% P.A i.e 0.875% for 3 months

After 3 months
F/0.7570 = 1 + 0.01875 / 1+ 0.00875, therefore F = 0.7645 UK £/US $

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