Answer: 1.22

## Explanation According to the **Interest Rate Parity (IRP)** theorem, the forward exchange rate can be calculated using the formula: \[ F = S \times \frac{(1 + r_d)}{(1 + r_f)} \] Where: - \( F \) = Forward exchange rate (USD/EUR) - \( S \) = Spot exchange rate = 1.25 USD/EUR - \( r_d \) = Domestic interest rate = 4% (USD rate) - \( r_f \) = Foreign interest rate = 7% (EUR rate) **Calculation:** \[ F = 1.25 \times \frac{(1 + 0.04)}{(1 + 0.07)} \] \[ F = 1.25 \times \frac{1.04}{1.07} \] \[ F = 1.25 \times 0.97196 \] \[ F = 1.21495 \approx 1.22 \] **Why this makes sense:** - The EUR has a higher interest rate (7%) than USD (4%) - According to IRP, the currency with higher interest rate should depreciate in the forward market - Therefore, the forward rate (1.22 USD/EUR) is lower than the spot rate (1.25 USD/EUR) - This creates an arbitrage-free condition where investors cannot profit from interest rate differentials alone The correct answer is **C. 1.22**

Author: LeetQuiz .