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Barclays Bank, as one of largest dealers in the foreign exchange markets, stands ready to be on the opposite side of every trade
Barclays Bank, as one of largest dealers in the foreign exchange markets, stands ready to be on the opposite side of every trade. The following information was given from the current market. Currency Interest Rate of Borrowing Interest Rate of Lending Dollar 5% 4.5% Euro 5.5% 5% Exchange Rate Bid Ask Spot Rate 1.42 $/€ 1.45 $/€ Forward Rate 1.413 $/€ 1.443 $/€ Requirement: Please set Barclays' suitable forward Bid and Ask price, respectively.
Expert Solution
Barclays Bank (Let us assume the bank is situated in USA)
Interest rate parity (IRP) is the fundamental equation that governs the relationship between interest rates and currency exchange rates. The basic premise of interest rate parity is that hedged returns from investing in different currencies should be the same, regardless of the level of their interest rates. Parity is used by forex traders to find arbitrage or other trading opportunities.
Calculation of forward rates based on IRP
Now, the spot rates are as follows
Bid rate 1Euro= 1.45$
Ask rate 1Euro= 1.42$
|
forward rate($/E) |
= |
spot rate x (1 + foreign interest rate) / (1 + domestic interest rate) |
|
Bid rate($/E) |
= |
1.45$ x (1+.05)/(1.045) = 1.457
|
Ask rate($/E) |
= |
1.42$ x (1+.05)/(1.045) = 1.427
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