The current USD/euro exchange rate is 1.4000 dollar per euro. The six month forward exchange rate is 1.3950. The six month USD interest rate is 1% per annum continuously compounded. Estimate the six month euro interest rate. If the six-month euro interest rate is rf th

the six month euro interest rate is 1.36%

Explanation:

Spot exchange rate: 1.4 USD / EUR

6 month forward rate: 1.3950 USD/EUR

Domestic interest rate: 1% pa

Foreign interest rate: the six month euro interest rate?

We have the formula:

Forward rates = Spot rate * (1+domestic interest rate) / (1+foreign interest rate)

⇔ 1.3950 = 1.4 * (1+1%) / (1+foreign interest rate)

⇔ 1+foreign interest rate = 1.4 * (1+1%) / 1.3950

⇔foreign interest rate = 1.01362 - 1 = 0.01362

⇒ the six month euro interest rate is 1.36%