2. (Ch. 5) Forward Premium. It is now on September 25. You observe the EURUSD spot
exchange rate is 1.0670 and the 1-year forward exchange rate is 1.0850 . a. What is the
annualized forward premium? (4 points) b. Based on the no-arbitrage condition, what is the
approximate one-year interest rate differential between the U.S. and the euro area? ( 3 points) c.
Which currency has a higher one-year interest rate? Why? ( 3 points) d. If you observe that the
one-year spot interest rate for the EUR is 3%, what is the oneyear spot USD interest rate? (2
points)
2. (Ch. 5) Forward Premium. It is now on September 25. You observe the EURUSD spot
exchange rate is 1.0670 and the 1-year forward exchange rate is 1.0850 . a. What is the
annualized forward premium? (4 points) b. Based on the no-arbitrage condition, what is the
approximate one-year interest rate differential between the U.S. and the euro area? ( 3 points) c.
Which currency has a higher one-year interest rate? Why? ( 3 points) d. If you observe that the
one-year spot interest rate for the EUR is 3%, what is the oneyear spot USD interest rate? (2
points)
If you hedge the same exposure as above by a forward contract but not the futures contract,
answer the following questions. (We assume that the futures exchange rates and the forward
exchange rates are the same and that there is no credit risk in trading the forward contracts.) f.
What is your hedging position (to buy or to sell) using the GBPUSD forwards? (2 points) g. Who
may be your counterparty? (2 points) h. What is the total cumulative profit or loss on this
forward position as of October 5? (4 points) i. What is the total cumulative profit or loss on this
forward position as of October 6? (4 points) j. Does anything happen on October 6 ? Why? ( 4
points).