Suppose that the one-year interest rate is 2.45 percent in the United States; the spot exchange rate is $1.1527/€; and the one-year forward exchange rate is $1.1231/€. What must one-year interest rate be in the euro zone to avoid arbitrage?
Spot Rate : - 1 Euro = $1.1527
Forward Rate : - 1 Euro = $ 1.1231
Forward Rate =
(1 + Europe Interest Rate) = 1.1527 * 1.0245 / 1.1231
(1 + Europe Interest Rate) = 1.05150133558
Europe Interest Rate = 1.05150133558 - 1
Europe Interest Rate = 5.15%
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