uppose the spot and six-month forward rates on the Norwegian krone are Kr 5.79 a

Question

uppose the spot and six-month forward rates on the Norwegian krone are Kr 5.79 and Kr 5.94, respectively. The annual risk-free rate in the United States is 3.59 percent, and the annual risk-free rate in Norway is 5.29 percent.

Using the approximation, the six-month forward rate on the Norwegian krone would have to be Kr/$  to prevent arbitrage.

uppose the spot and six-month forward rates on the Norwegian krone are Kr 5.79 and Kr 5.94, respectively. The annual risk-free rate in the United States is 3.59 percent, and the annual risk-free rate in Norway is 5.29 percent.

Explanation / Answer

For solving the question, we have to apply the interest rate parity approximation formula.The formula is:

Forward Rate = Spot rate x [(1 + Ih ) / (1 + If )]t

Where,

Ih = Interest rate on home currency = 5.29 %

If = Interest rate on foreign currency = 3.59 %

t = time period = 1/2 years

putting the value on the above formula.We have,

Forward rate = 5.79 x[ ( 1 + 0.0529) / ( 1 + 0.0359)]1/2

Forward rate = 5.79 x [ 1.0529/1.0359]1/2 = 5.79 x 1.0082 = 5.84

Hence, as per interest rate parity approximation formula, the six-month forward rate on the Norwegian krone would have to Kr 5.84 / $.

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