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. | |||||
Get Answers For Free
Most questions answered within 1 hours.