Question

# Current spot rate of SF = \$0.6543; 1-year interest rate in the U.S. = 7.5%; 1-year...

Current spot rate of SF = \$0.6543; 1-year interest rate in the U.S. = 7.5%; 1-year interest rate in the Switzerland = 3.5% If one year later, the spot rate for SF turns out to be \$0.6625, according to IFE, would SF be overvalued or undervalued in real terms?

a. Overvalued

b. Undervalued

calculation and explanation!!!

 Spot rate 1 SF \$ 0.6543 Interest rate in US 7.5% Interest rate in Switzerland 3.50% Forward rate formula = Sport rate * (1 + U.S. interest rate)^n / (1+ Swis. interest rate)^n Forward rate = 0.6543 * (1+0.075/(1+0.035) \$0.6796 Theoritical forward rate is 1 SF = \$0.6796 While actual forward rate is 1 SF = 0.6625 It means SF is undervalued in real terms.As per interest rate parity theory, price of 1 SF should be equivalent to \$ 0.6796 But in real terms, it is only \$0.6625. We can buy less dollar for SF in comparison to theoritical price. So SF value is kess than theoritical price. So, it is undervalued in real terms.

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