Question

Suppose the spot rate and the 90-day forward rate on the Brazilian real are 5.1101 and 5.1273, respectively. If the three-month interest rate on dollars is 0.40%, what do you think is the three-month interest rate on the Brazilian real?

Answer 1

The three-month interest rate on the Brazilian real is 0.73%.

Step-by-step explanation:

To determine the three-month interest rate on the Brazilian real, we can use the concept of covered interest rate parity. According to this concept, the forward exchange rate should equal the spot exchange rate multiplied by (1 + the domestic interest rate) divided by (1 + the foreign interest rate).

In this case, the spot rate on the Brazilian real is 5.1101 and the 90-day forward rate is 5.1273. The three-month interest rate on dollars is 0.40%. Let's assume the three-month interest rate on the Brazilian real is 'r'.

Using the covered interest rate parity formula:

5.1273 = 5.1101 * (1 + 0.0040) / (1 + r)

Simplifying the equation:

r = (5.1101 * (1 + 0.0040) / 5.1273) - 1 = 0.0073, or 0.73%