Question

4. 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

Solution :-

• Forward Rate, F = 23.81

• Current Spot rate, S = 25

• Domestic interest rate, iegypt= 5%

• Foreign interest rate, iJD

As per the Covered Interest Rate Parity, the formula is :-

F = S [(1+ iegypt)/(1+ iJD)]

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

(1+ iJD) = 1.05/0.95

iJD = 10.5%

rJD = iJD - ^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%.