Problem 20-10 Exchange Rates and Arbitrage Suppose the spot and 180-day forward
ID: 2795220 • Letter: P
Question
Problem 20-10 Exchange Rates and Arbitrage
Suppose the spot and 180-day forward rates on the Norwegian krone are Kr 5.82 and Kr 5.97, respectively. The annual risk-free rate in the United States is 3.62 percent, and the annual risk-free rate in Norway is 5.32 percent.
The 180-day forward rate on the Norwegian krone would have to be Kr/$ to prevent arbitrage. (Do not round intermediate calculations and round your final answer to 4 decimal places (e.g., 32.1616).)
Suppose the spot and 180-day forward rates on the Norwegian krone are Kr 5.82 and Kr 5.97, respectively. The annual risk-free rate in the United States is 3.62 percent, and the annual risk-free rate in Norway is 5.32 percent.
Explanation / Answer
Problem 20-10:Exchange Rates and Arbitrage
F = S (1+id) / (1+if)
where,
F = Forward Rate,
S = Spot Rate,
id = Interest rate in domestic country,
id = Interest rate in foreign country.
F = 5.82 (1+5.32%) / (1+3.62%)
= 5.82 (1.0532) / 1.0362
= 6.1296 / 1.0362
= 5.9155
The 180-day forward rate on the Norwegian krone would have to be Kr/$ 5.9155 to prevent arbitrage.Round off to Kr/$ 5.92
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