Question on Schweser practice exam #1, afternoon (MCQ) question

[amr5434]

Hello - I have a question on #34, afternoon practice exam #1. According to the solution, the Euro is expected to depreciate by 0.2% (and will trade at a forward discount). However, given that the Euro has the HIGHER risk-free rate, shouldn’t it appreciate (and trade at a forward premium)? The solution makes no sense to me, wondering if there’s something I’m missing. Thanks in advance.

 

[Audacious]

Euro is the base (B).
according to IRP: F/S= (1+RF_P)/(1+FR_B)
If the RF is higher for the Base currency, then the denominator will be higher, which means the forward price will be lower (trading at a forward discount)

 

[S2000magician]

The currency with the higher risk-free rate trades at a forward discount.
If the EUR risk-free rate is 1% and the USD risk-free rate is 3%, then in the future 1% more EUR will buy 3% more USD, or 3% more USD will buy 1% more EUR; the EUR appreciates (about 2%) vis-à-vis the USD, and the USD depreciates (about 2%) vis-à-vis the EUR.