The current bank interest of America and India are 4.5% and 8.5% respectively. The present spot market rate of exchange in US $ is ₹ 62.10. What would be the twelve month forward rate ?

The correct answer is - 64.47

Key Points

• Forward Rate Calculation
  • The formula for calculating the forward exchange rate is based on the Interest Rate Parity:
    Forward Rate = Spot Rate × (1 + Interest Rate of Domestic Country) / (1 + Interest Rate of Foreign Country).
  • In this case:
    • Spot Rate (₹/$): 62.10
    • Interest Rate in India: 8.5% or 0.085
    • Interest Rate in America: 4.5% or 0.045
  • Substitute values into the formula:
    Forward Rate = 62.10 × (1 + 0.085) / (1 + 0.045)
    Forward Rate = 62.10 × 1.085 / 1.045
    Forward Rate = 64.47
• Correct Answer Explanation
  • The option 64.47 correctly applies the formula and aligns with the given data.
  • The forward rate reflects the effect of the difference in interest rates between India and the US.

Additional Information

• Interest Rate Parity
  • It is a fundamental concept in foreign exchange markets that links spot exchange rates, forward exchange rates, and interest rates of two countries.
  • The formula assumes no arbitrage opportunities in the currency markets.
  • Higher interest rates in one country typically result in a depreciation of its currency in the forward market.
• Spot Exchange Rate
  • Defined as the current price of one currency in terms of another currency for immediate delivery.
  • It is influenced by factors such as economic stability, trade balances, and market demand.
• Forward Exchange Rate
  • The rate agreed upon today for exchanging currencies at a specific future date.
  • Used to hedge against exchange rate risk in international trade and investments.
  • Forward rates reflect differences in interest rates between two countries.