The US dollar is selling in India at Rs.55.50. If the interest rate for a 6 months borrowing in India is 10% per annum and the corresponding rate in USA is 4%.

(i) Do you expect that US dollar will be at a premium or at discount in the Indian Forex Market?

(ii) What will be the expected 6-months forward rate for US dollar in India? and

(iii) What will be the rate of forward premium or discount?

Solution

• Under the given circumstances, the USD is expected to quote at a premium in India as the interest rate is higher in India
• According to IRP

F/S = 1+iA/ 1+iB

Where

F       = Forward Rate

S       = Spot Rate

iA      = 6 month interest rate in India

= 10% p.a = 5% for 6 months

iB      = 6 months interest rate in USA

= 4% p.a = 2% for 6 months

After 6 months,

F/ 55.5 = 1.05/ 1.02, therefore F = Rs. 57.13

• Forward Premium on $ = F-S/ S x 100 x 12/n

57.13 – 55.5/ 55.5 x 100 x 12/6 = 5.87%

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