Question

Find the interest rate on Jordanian government securities with one-year maturity given expected rate of inflation in Jordan is 8 percent. The interest rate on Egypt government securities with one-year maturity is 5 percent and the expected inflation rate in Egypt for the coming year is 3 percent. The current spot exchange rate for Jordanian currency is 1 JD = 25 Egyptian currency and the forward exchange rate for Jordanian currency is 1 JD = 23.81 Egyptian currency. Show the steps of your answer

Answer 1

Forward Rate, F = 23.81

Current Spot rate, S = 25

Domestic interest rate, i_egypt= 5%

Foreign interest rate, i_JD

According to Covered Interest Rate Parity, the formula is:

F = S [(1+ i_egypt)/(1+ i_JD)]

23.81 = 25 [(1 + 0.05)/(1+ i_JD)]

(1+ i_JD) = 1.05/0.95

i_JD = 10.5%

r_JD = i_JD - ^e = 10.5% - 8% = 2.5%

nominal interest rate on Jordanian government securities with one year maturity is 10.5 % and real interest rate is 2.5%.