Explanation:
D is correct. The forward rate, F, is given by the interest rate parity equation:
F = S * (1 + R_USD)^T / (1 + R_EUR)^T
where: S is the spot exchange rate, R_USD is the USD risk-free rate, R_EUR is the EUR risk-free rate, and T is the time to delivery.
Substituting the values in the equation: F = 1.13 * (1 + 0.027)^2 / (1 + 0.017)^2 = 1.1523
This calculation shows that the 2-year forward exchange rate should be higher than the spot rate (1.13) because the USD interest rate (2.7%) is higher than the EUR interest rate (1.7%), which means USD is expected to depreciate relative to EUR in the forward market.
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A currency analyst is examining the exchange rate between the USD and the EUR. The analyst observes the following market data:
According to interest rate parity, what is the 2-year forward USD per EUR 1 exchange rate?
A
1.1081
B
1.1190
C
1.1411
D
1.1523