Suppose you observe the spot euro at $1.50/€,the U.S.risk-free interest rate of 3.25% (continuously compounded),and the six month futures price of $1.50/€.Identify the correct implied European risk-free interest rate (select the closest answer).
A)-3.25%
B)-1.0%
C)0.0%
D)1.0%
E)3.25%

Question

Quizplus · Accepted Answer

The futures price at expiration must equal the spot price plus the risk-free interest rate. Therefore, if the futures price is the same as the spot price, then the risk-free interest rate must be equal to 3.25%. This is because if it were higher, the futures price would be higher than the spot price, and if it were lower, the futures price would be lower than the spot price. Therefore, the implied European risk-free interest rate is 3.25%.

Suppose You Observe the Spot Euro at $1