You are a foreign exchange trader specialized in the US dollar Swiss franc market (USD/CHF). One morning, you notice that the one-year dollar interest rate is 4%, while the one-year interest rate on Swiss francs is 2.7%. Today’s USD/CHF rate is $1.7. What spot rate do you expect for the USD/CHF in one year?
1 USD today will be worth 1.04 USD in 1 year. Similarly, 1.7 CHF today will be worth 1.7459 CHF in 1 year. As a result, we can expect the USD/CHF rate in one year to simply be 1.7459/1.04 = 1.67875.