Question

Suppose the current exchange rate between the United States and France is $1.25/€. The continuously compounded interest rate in the U.S. is 4%, while the continuously compounded euro-denominated interest rate is 7%. What is the price of a 6 -month prepaid forward contract on the euro? Please work out and show all steps. Thank you.

Answer 1

price of a 6 -month prepaid forward contract = current exchange rate * erus*t / ere*t

where rus = risk free rate in US. This is 4%, or 0.04.

re = risk free rate in France. This is 7%, or 0.07.

t = time to maturity of contract (in years). This is (6/12), or 0.5.

price of a 6 -month prepaid forward contract = current exchange rate * erus*t / ere*t

price of a 6 -month prepaid forward contract = 1.25 * e0.04*0.5 / e0.07*0.5

price of a 6 -month prepaid forward contract = $1.2314/€