Question

Suppose the interest on a foreign government bonds is 7.5%, and the current exchange rate is 28 foreign currencies per dollar. If the forward exchange rate is 28.5 foreign currencies per dollar, and the current US risk-free rate is 4.5%, what is the implied risk premium of the foreign government bond?

Answer 1

Answer :

Implied Rate = ( forward rate / current rate) raised to the power of (1/ time) -1

Here, forward exchange rate is 28.5, Current exchange rate 28

= (28.5/28) - 1

= 1.8%

Implied risk premium = rf + b * (rm - rf)

Here, risk free rate is 4.5% , Market return 7.5%

= 4.5% + 1.8%*(7.5%-4.5%)

= 4.6%

hence, implied risk premium of government bond is 4.6%