Module 18.2: Forward Exchange Rates

Question 1

How are forward rates typically stated against spot rates?

Answer 1

by using “points” which are stated in units as of the last decimal point in the spot rate

Question 2

What is the difference between a currency spot rate and forward rate?

Answer 2

it is approximately equal to the difference between the two countries’ interest rates.

Question 3

Explain the possible arbitrage opportunity in the forward currency market?

Answer 3

Borrow currency A at interest rate A, convert it to currency B at the spot rate and invest it to earn interest rate on B, and sell the proceeds from this investment forward at the forward rate back to currency A.

Question 4

What is the formula for the no-arbitrage relation (interest rate parity)

Answer 4

forward / spot = (1 + interest rate prince currency) / (1 + interest rate base currency)

Question 5

What is the forward discount or premium? If there is a premium, is the currency expected to appreciate or depreciate?

Answer 5

It is the percentage difference between the forward price and the spot price.

Currency will be expected to appreciate and the base currency will be expected to depreciate.

Question 6

How does the interest rate parity formula change if the forward rate is not a year?

Answer 6

divide the annual risk free rate by N (so 90 days would be annual interest rate / 4)

Question 7

If it takes fewer NZD to buy one USD in the forward market than in the spot market, what does that mean for interest rates in both countries?

Answer 7

the interest rates will be higher in USD.