This question is from the text book (Economics page 593 question 3) and I can’t see where I have gone wrong You are given the ff quotes: Spot rates /EUR 1.1865-1.1870 Yen/ 108.1 – 108.2 3-month interest rates (percent per year) in 5-5 1/4 in EUR 31/4 – 31/2 in Yen 11/4 – 11/2 What should the quotes be for the a. /EUR 3-month forward ask exchange rate b. EUR/ 3-month forward bid exchange rate c. Yen/ 3-month forward bid and ask exchange rate Focusing on question a. alone this is what I did: /EUR rate is 1.1870(1 + 0.0525/4)/(1+0.035/4) This is what CFAI did: /EUR rate is 1.1870(1+0.0525/4)/(1+0.0325/4) Why am I wrong?
Hi Grace, I think the answers is in the tip provided: you’re going to buy $ using the bid and sell euros (using the ask)
hi pullbacking, thanks for ur help but can you walk me tru step by step…i know the formular but when we talk of buying one currency and selling another then i get blanks…please do come back. this thing has consumed over three hours of my time and i am just not getting a hold of it…
Ok Grace, Lets do the 1st case together: "/EUR 3-month forward ask exchange rate" Given data Spot /Euro: 1.1865 - 1.1870 IR()(bid) = 0.05 IR()(ask) = 0.0525 IR(Euro)(bid) = 0.0325 IR(Euro)(ask) = 0.0350 Basic IRP Eq [FR(/EURO)]/[SR(/EURO)] = [1 + IR()]/[1+IR(Euro)] Modify it for 3-month Ask [FR(/EURO)(Ask)]/[SR(/EURO)(Ask)] = [1 + IR()(Ask)(3/12)]/[1+IR(Euro)(Bid)(3/12)] [FR($/EURO)(Ask)] = 1.1870 * [1 + 0.0525/4]/[1 + 0.0325/4] = ANS Confused you even more??
hi Dinesh, thanks for all your efforts …do take a look at the denominator on the right hand side: why is it IR(Euro) BID and not IR (EUR) ASK since everything else in your formular is for the ASK? thanks for the hlp so far, will appreciate further clarification please
/Euro 3-months forward ask - means you want to buy Euro 3 months from now. Which is equivalent to saying that you borrow to buy Euros in the spot market and invest those euros. [SR(/EURO)(Ask)] = (ask) buy euors spot @ SR [1 + IR()(Ask)(3/12)] = (ask) borrow [1+IR(Euro)(Bid)(3/12)] = (bid) lend euros ------------------------------------------------------ These 3 transactions are equivalent to buying euors 3-months from now. ------------------------------------------------------- Hence the formula: [FR(/EURO)(Ask)] = [SR(/EURO)(Ask)]\*[1 + IR()(Ask)(3/12)]/[1+IR(Euro)(Bid)(3/12)]
Dinesh, pullbackking, and all the guys Thanks for bringing light my path: see how I finally reasoned it out. It is a bit windy but so take a look at it for your ‘ok’ so i can take a siiiiiiigh hahahahaha: 1. /EUR 3-month forward ask exchange rate is like buying EUR 3 months from now this is like borrowing the dollar equivalent of a EUR today to invest; this will be worth {1 + R eur bid } in 90 days. (The banks will not give me their ask they will give me their bid) Call this A. This is the same as: 3. borrowing the equivalent of one eur 1.187 today at R ask. To give me 1.187 {1+R$ ask} in 90 days. I convert it to EUR at the forward rate of F to give me 1.187{1+R$ ask}/F eur. Call this B A =B 1.187{1+R$ ask}/F = {1 + R eur bid} F = 1.187{1+R$ ask}/ {1 + R eur bid} Is this thinking jun 7th compliant?