ExpertMedium2 marksShort Answer
ACCA · Question 14 · Risk Management
'MicroLend', a microfinance institution, is analyzing exchange rates. The current spot rate is 1.5000 USD/GBP. The 1-year interest rate in the US is 4%, and the 1-year interest rate in the UK is 6%.
According to Interest Rate Parity (IRP), calculate the 1-year forward exchange rate (USD/GBP).
(Enter your answer to four decimal places, e.g., 1.2345)
'MicroLend', a microfinance institution, is analyzing exchange rates. The current spot rate is 1.5000 USD/GBP. The 1-year interest rate in the US is 4%, and the 1-year interest rate in the UK is 6%.
According to Interest Rate Parity (IRP), calculate the 1-year forward exchange rate (USD/GBP).
(Enter your answer to four decimal places, e.g., 1.2345)
How to approach this question
Apply the Interest Rate Parity formula: Forward = Spot × ((1 + Interest Rate of Quote Currency) / (1 + Interest Rate of Base Currency)). Here, GBP is the base currency.
Full Answer
The IRP formula is F0 = S0 × ((1 + ic) / (1 + ib)), where ic is the interest rate of the quote currency (USD) and ib is the interest rate of the base currency (GBP).
F0 = 1.5000 × (1 + 0.04) / (1 + 0.06)
F0 = 1.5000 × (1.04 / 1.06)
F0 = 1.5000 × 0.981132 = 1.471698...
Rounding to four decimal places gives 1.4717.
Common mistakes
Putting the UK interest rate in the numerator and US in the denominator, resulting in 1.5288.
Practice the full ACCA FM — Financial Management Practice Exam 3
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