Klaus is reviewing the relationshop between US dollar and the British pound. On the spot market the dollar to pound exchange rate is USD 1.85 / Pound, while the six month forward market pound to dollar exchange rate is Pound 0.50/USD. Indicate whether the forward pound is selling at a premium or discount and calculate the amount of the premium/discount. A) Premium / 15% B) Discount / 15% C) Premium / 16.2% D) Discount / 16.2%
i think answers c and d should be 1.62% and I believe answer should be C premium 1.62% CP
C EDIT - Just invert the forward rate to get 2 USD/GBP so the forward is more than the spot which means FOREIGN is at a premium, and then annualize the % change using 360/180
Dont we need to convert it in pound/dollar since they have asked us wrt pound. ?
C is right… but how do I know when to invert the spot (USD 1,85/ pound) or the forward rate? I agree with smeet… it asks for the forward pound…
dollar/pound is the price of the pound. When you are asking for how much the pound sells for…you are asking for the price of the pound.
when they ask about fwd/premium for a particular currency, make that the foreign currency in your calcs. so in this case spot stays as is (quoted from the point of view of a US broker), but flip the forward one, to make it again direct for USD. Then if the annualized result is > 0 foreign currency trades at premium. You can also rationalize it too, if you get confused with what means what - today you need 1.85USD to buy a pound, in 6 months, you’ll need 2USD to get a pound, therefore the pound has appreciated relative to USD.
What I do is see if the currency in question is worth more or less. In this case, the “now” price is 1.85 USD/1 GBP and the “future” price is 2 USD/1 GBP. In other words, 1 GBP gets you more USD in the future, so it’s more expensive in the future. Therefore the fwd is at a premium. In other words what lola put at the end… (which I just read)
pound/dollar : [(0.5-1/1.85)/0.5]*2 = 16.22 dollar/pound: [(1.85-2)/1.85]*2 = -16.22 from dollar perspective. i think… i need a break.
YEs tat is rt… another way is to invert both of them so u get 0.56pounds/dollar and 0,5 pounds a dollar. If u calculate premium using this method, you will get 15%
Yup had made a mistake thre…