Going nuts over this…I know F/S = 1+rFC/1+rDC…but in part A, the solution shows 0.90 (1.0315/1.0478), indicating rDC/rFC instead…what am I brain farting on here? Thanks.
I can only remember myself of the numerator / denominator rule. If the exchange rate is quoted as DC / FC (as in this case), then also the rates should be as 1+rDC / 1 + rFC. However I also struggle to align it with the interest rate parity. Would someone please bring some more clarity into it? Thanks!
The way I interpret forward exchange rates is to first always work with direct quotes (FC:DC or using the alternative notation DC/FC) because this tells us the price of one unit of foreign currency. This fits well into the formulas introduced in the readings on futures and forwards, those formulas use the spot price (i.e. in this case the spot is the price of a unit for foreign currency). I then recall that the futures price equals spot multiplied by the domestic risk free rate, i.e.: Spot x (1 + rDC)^T With forward exhange rates we miss out on the risk free return in the foreign currency (we would have got this return if we exchanged using the spot rate and invested in the foreign currency) so we need to subtract that return, or in this case we divide by 1 + that return. This gives us: Spot x (1 + rDC)^T / (1 + rFC)^T Hope that helps. Cheers