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4 December, 19:21

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

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  1. 4 December, 19:32
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    implied credit spread = 1.13 %

    Explanation:

    given data

    interest on foreign government bonds = 7.5%

    current exchange rate = 28

    forward exchange rate = 28.5

    risk-free rate = 4.5%

    solution

    we get here risk free rate by the forward exchange rate that is

    F = spot exchange rate * / frac{1+Rr}{1+Rs} ... 1

    put here value

    28.5 = 28 * / frac{1+Rr}{1+0.045}

    solve it we get

    Rr = 0.0637

    Rr = 6.37%

    so

    implied credit spread = interest on foreign government bonds - risk free rate

    implied credit spread = 7.5% - 6.37%

    implied credit spread = 1.13 %
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