Question

Suppose the spot and six-month forward rates on the Norwegian krone are Kr5.78 and Kr5.93, respectively. The annual risk-free rate in the United States is 3.58 percent, and the annual risk-free rate in Norway is 5.28 percent.

The six-month forward rate on the Norwegian krone would have to be Kr ------------ /$ to prevent arbitrage.

Answer 1

In this case

Spot rate of Norwegian krone is Kr 5.78

Risk free Interest rate in Norway is 5.28% which is 0.0528

Risk free Interest rate in USA is 3.58% which is 0.0358

Now we have to compute the forward rate for 6 months which can be written as 6/12 or 1/2.

Now the formula for giving six month forward rate on Norwegian Krone to prevent arbitrage is:

F(6 months)= Spot rate of Norweigan Krone[1+(Norway risk free rate- USA risk free rate)]^Time period of future contract

= 5.78[1+(0.0528-0.0358)]^1/2

= Kr. 5.8289