Page 42 - FINAL CFA SLIDES DECEMBER 2018 DAY 6
P. 42

Session Unit 5:

                                                                                           20. Currency Exchange Rates


    LOS 20.h: Calculate and interpret the forward rate consistent with the spot rate and the interest rate in each

    currency, p.162

      Example: Calculating the arbitrage-free forward exchange rate: Consider So = ABE/DUB =

      4.5671, the 1-year riskless ABE rate is 5%, and the 1-year riskless DUB rate is 3%. What is the

      1-year forward exchange rate that will prevent arbitrage profits?


                                                           Note that the forward rate is greater than the spot

                                                           rate by 1.94% (=4.6558 / 4.5671 – 1)



















      This is approximately equal to the interest rate differential of 5% – 3% = 2%.


       The currency with the higher interest rate should depreciate over time by approximately the

       amount of the interest rate differential.
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