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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