The current spot exchange rate is $1.20/euro. The current 90-day forward exchange rate is $1.18/euro. You expect the spot rate to be $1.22/euro in 90 days. How would you speculate using a forward contract? If many people speculate in this way, what pressure is placed on the value of the current forward exchange rate?

.The following rates are available in the markets:

• Current spot exchange rate: $1.000/SFr
• Current 30-day forward exchange rate: $1.010/SFr
• Annualized interest rate on 30-day dollar-denominated bonds: 12% (1.0% for 30 days)
• Annualized interest rate on 30-day Swiss franc-denominated bonds: 6% (0.5% for 30 days)

a.Is the Swiss franc at a forward premium or discount?

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b.Should a U.S.-based investor make a covered investment in Swiss franc-denominated 30-day bonds, rather than investing in 30-day dollar-denominated bonds? Explain.

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c.Because of covered interest arbitrage, what pressures are placed on the various rates? If the only rate that actually changes is the forward exchange rate, to what value will it be driven?

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