This is going to sound stupid, but for some reason I always have trouble quickly figuring out whether a currency appreciated or depreciated when given a spot and future exchange rate. Can someone out there explain an easy way to figure this out using numerator denominator rules?
I sometimes get confused - it’s not always intuitive. The way I look at it - I run through a scenario. Spot = $1.50/GBP What does that mean? It means that an investor can exchange 1 GBP and receive $1.50 USD. I like to put it in terms of the denominator being 1. Moving on let’s say the Forward Rate = $1.60/GBP What does that mean? It means that an investor can exchange 1 GBP and receive $1.60 USD in the future. The GDP now buys more of the USD and has appreciated.
Look at the number in the numerator. If it has gone up from spot (at t=0) to future at (t=0+X) then the numerator currency is expected to depreciate. So the numerator currency moves in the opposite direction of the number in the numerator. For example, 0.8 Euro/Dollar --------> 0.9 Euro/ Dollar In this case the number in the num went up, so the Euro had to depreciate. It now takes more Euros, 0.9 vs 0.8 to buy 1 dollar. Edit: VA beat me to it.
Thanks guys! That helps a lot. Not quite sure why I have had such a hard time wrapping my head around it.
$1.5/GBP means it cost me $1.5 to buy GBP, $1.6/GBP measn it cost me $1.6 to buy GBP, it is costing me more to buy GBP, so GBP went up/appreicated.
think of one of the currencies as a thing, like a big mac, and you’ll be quickly able to tell whether its increasing or decreasing.
i don’t like formulas - i think in terms of beers. step 1 is: always convert currencies to “Domestic over Foreign” (why? Domestic beers ALWAYS win over Foreign german/dutch/japanese/etc watered down over-priced crap) (eg. so when given a dollar:yen rate of 85 or whatever, always need to convert to DC/FC rate of 0.0117 $/yen) Once rates are in DC/FC terms you just think of it as the price of beer. If the current spot price is 0.0117 per beer, but the Fwd price is 0.02 per beer, the Fwd beer is more expensive so beer is at a Fwd premium --> will rise in future. If the Fwd price per beer (or yen or whatever) is less than the spot price, the Fwd is at a discount --> will fall in future. Some people use a can of peas, but you can’t skull a can of peas. You can throw up hurl a can of peas (even if you haven’t eaten peas for weeks), but you can’t drink one, so I use beer instead. Must be time for a beer…