Assume 3 month US T bills have a nominal rate of 8 percent, while default free European bond that mature in 3 months have a nominal rate of 6 percent. In the spot exchange market, one Euro equals…

Solution: 6-Month Forward Exchange Rate under Interest Rate Parity

Given:

• US 3-month nominal rate (r₁) = 8% → 6-month rate (r₁₆) = 8% × 2 = 16% (assuming annualized compounding).
• Euro 3-month nominal rate (r₂) = 6% → 6-month rate (r₂₆) = 6% × 2 = 12%.
• Spot rate (S₀) = $1.15/Euro.

Using Interest Rate Parity (IRP) for forward exchange rate (F₆): $$F_6=S_0\times \frac{1+r_{16}}{1+r_{26}}$$ $$F_6=1.15\times \frac{1+0.16}{1+0.12}=1.15\times \frac{1.16}{1.12}=1.15\times 1.0357=\ast \ast 1.1913\ast \ast$$

Answer: The 6-month forward exchange rate is $1.1913 per Euro.