FWR = Spt x (1 + R d) / (1 + R f), so 4 x (1.08) / (1.06) = 4.07547 =====> A Remember that the interest rates will be the same way the currency is. In other words, if the currency is quoted domestic/foreign, then the domestic interest rate will go on top.
CP, I am very jealous sir… you dont miss… same to you swaption… Your answer: B was incorrect. The correct answer was A) 4.075. Using the following interest rate parity equation: ForwardDC/FC=SpotDC/FC × [(1 + rdomestic) / (1 + rforeign )] Solving for the forward rate: ForwardDC/FC = 4 × [(1 + 0.08) / (1 + 0.06)] = 4(1.08) / (1.06) = 4(1.01887) = 4.07547 Every time I see interest parity, the following equation pops up in my head: F/S = [(1+rfc)/(1+rdc)]… but then again, this is when quoting dc:fc, not dc/fc… I feel like i have to relearn all of these forumlas for dc/fc… Does anyone have any speculation of this appearing on the test asf dc:fc or dc/fc???
“Remember that the interest rates will be the same way the currency is. In other words, if the currency is quoted domestic/foreign, then the domestic interest rate will go on top.” good advice clama… I assume this works for all my parity formulas since i memorized them all as 1+FC/1+DC… But this was when it was quoted as DC:FC, which i have learned is an indirect quote
My approach: The country whose interest rate is higher has to depreciate going forward (in this case domestic). By how much is given by 1.08/1.06. Not sure if this logic always works! Any advice folks?
Direct quotes --> FC:DC = 5 It’s called a direct quote to the domestic currency because I know that I need exactly 5 units of DC to make one unit of FC. Direct quotes will always “tell you” how many units of that currency you need to make 1 unit of another currency. CAD:USD = 0.8. I need 0.8 USD to make 1 CAD, therefore it is a direct quote for an American
I have a short cut. When calculating Forward: F= S* (i+b)/(i+a) When calculating spot S= F*(i+a)/(i+b) Now for my memory I say Foreign is something outside. Away from me. Like an alien. So always pair Forward and alien i.e. the int rate in the foreign country. And base is home. Where the heart is. So pair base with spot. IF you are the logical kind and dont like this make believe stuff, then remember the numerator: denominator rule. Num= upper value; denominator = lower value So just remember b in numerator. Fix it in the mind. For forward value, its Num/Denominator. U’ll know then “a” in denominator. When you are taking values in future or going forward. When you discount back to present or are returing to spot, remember its the inverse. To come back, its denominator/ numerator. Already we’ve fixed “b” in numerator. It seems simple to me. Hope it was of some help!