(1+ id)= Sf/d (1+ if) (1/ Ff/d)
Hi,
In the above equation, the domestic/foreign interest rate, are they annual rate?
I saw a question using 90 days interest in the formula. (180 days interest divided by 2)
Help please!
Thank you.
It depends on the rate that is quoted. When calcuating using this equation, pay special attention to the time frame referenced. The 90-day forward rate using 360-day LIBOR would be based on 90/360 of the quoted LIBOR plus 1.
If you have a 90-day forward exchange rate, then you use 90-day interest rates; if you have a 360-day forward exchange rate, then you use 360-day interest rates. And so on.
As FratBoy mentioned, the rates will be quoted as annual rates; you need to change them to effective rates for the period in question.
Finally, remember that LIBOR rates are nominal rates, not effective rates.
Here are a couple of articles that I wrote that may help:
- Interest Rate Parity: http://financialexamhelp123.com/covered-interest-rate-parity-irp-pricing-currency-forwards/
- Nominal vs. Effective Interest Rates: http://financialexamhelp123.com/nominal-vs-effective-interest-rates/
Thank you guys!
My pleasure.