Suppose you observe a spot exchange rate of $1.0500/€. if interest rates are 3 percent apr in the u. s. and 5 percent apr in the euro zone, what is the no-arbitrage 1-year forward rate?

The 1 year forward rate with no arbitrage would be $1.03/ €

Explanation:

GIVEN INFORMATION -

Spot exchange rate ( S ) - $1.0500/€

US interest rate ( u ) = 3%

Euro zone interest rate ( e ) = 5%

For calculating the forward rate ( F )  we can use the following formula -

( 1 + u ) = F / S  ( 1 + e )

( 1 + 3% ) = F / 1.0500  ( 1 + 5% )

1.03 = F / 1.0500  x 1.05

F = 1.03 x 1.0500 / 1.05

  = 1.0815 / 1.05

  = 1.03

Therefore the forward rate is $1.03/ €.

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