Edit: DO NOT READ THE POST ABOVE MINE - HE IS WRONG. If you have to BUY a million USD at a rate of 0.85 USD/CHF then it will cost you MOOOOOORE THAN 1 million CHF. In order to buy 1 million USD it will cost you 1,176,471 francs (NOT 850,000).
I’m happy to explain. This question, is totally made up and routed deeeeeeeep in something we call “la la land”.
You’re not going to find a market where someone’s willing to take the contra side of that forward contract when the price currency interest rate is 6% higher than the base. The market would swoop on those arbitrage profits soooooooo fast.
In your example you understand that swiss francs are trading at a forward discount, when given the laws of uncovered interest rate parity they ought to be trading at a premium.
18% - 12% = 6% that we would expect the dollar to weaken by over this time frame not STRENGTHEN.
Now, all that aside, you really shouldn’t struggle to understand that if you borrow in swiss francs, invested in USD markets, and then bought that forward contract to convert back to francs for a notional of 1million US you earn a riskless profit of 92,529.07 swiss francs. I used the quarterly compounding method and not simple interest to get this number btw - on the exam, either way is sufficient.
It’s weird that they’re asking you to calculate this in terms of a million dollars. You obviously wouldn’t be borrowing in the US market if those rates were higher. So, to be fair, they should have told you to start in francs.
Also, understand that for a carry trade to work out, the currency of the higher interest rate country needs to depreciate by LESS than dictated by uncovered interest rate parity.