Having trouble with this Econ Question about forward premiums and interest rates.

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bandabears

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If the currency forward rate is trading at a premium, then relative to the interest rate of the domestic country, the interest rate in the foreign country is most likely:
higher.
the same.
lower.
Incorrect.
The currency with the higher (lower) interest rate will always trade at a discount (premium) in the forward market.
 
You can see from the formula , if you know it than it is simple .
F (d/f)= S(d/f)* (1+Id)/ (1+If)
So for the forward rate to be trading at premium to the spot rate than the numerator have to be bigger than denominator => Id>If in this case Interest rate in the foreign currency have to be lower relative to the rate in domestic currency
 
I thought that the formula would become higher and since your numerator is the foreign while your denominator is domestic that this means that your interest rate on top would need to be higher. Is the foreign meant to be on the bottom?
 
I thought that the formula would become higher and since your numerator is the foreign while your denominator is domestic that this means that your interest rate on top would need to be higher. Is the foreign meant to be on the bottom?
For example: If the starting is 100CAD/100USD and the forward premium becomes 110CAD/100USD
Then wouldn’t the formula to get there have to be: 100CAD/100USD x (1+int CAD/ 1+int USD) meaning that the interest rate of the CAD would have to be higher?
 
Just remember that if a currency is trading a forward premium relative to another currency, then the interest rate in the domestic currency is lower than the interest rate in the foreign currency. No need to calculate it
 
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