Currency Forward Pricing Valuation Analysis

Very Hard Forward Pricing And Valuation Currency Forwards

A financial analyst is evaluating a currency forward contract to hedge exposure to fluctuations in the exchange rate between the Euro (EUR) and the US Dollar (USD). The analyst notes the following information:

- Spot exchange rate (EUR/USD): 1.2000

- 6-month forward exchange rate (EUR/USD): 1.2500

- Risk-free interest rate in the Eurozone: 2% per annum.

- Risk-free interest rate in the US: 1% per annum.

The analyst is tasked with determining whether the forward rate is appropriately priced based on the interest rate parity theory.

Which of the following statements is true regarding the forward pricing and valuation of the currency forwards for the given situation?

The EUR/USD forward rate is overpriced because the forward rate should be lower than the spot rate given the relative interest rates.

The EUR/USD forward rate is correctly priced as it reflects the interest rate differential between the two currencies.

The EUR/USD forward rate is underpriced because the forward rate should equal the spot rate multiplied by the ratio of the interest rates.

Hint

Submitted5.4K

Correct5.2K

% Correct96%