Like a few other ppl on here I’m trying to really grasp the concept of interest parity and after working through several q’s that have been posted here over the last few days, I have a couple of basic questions, still… 1. I basically understand 1+rd vs. 1+rf x (f-s/s) and how to solve from there, but for the currency quotes, do I need to make sure they are set up as direct quotes for the domestic country? 2. If the spot rate equals .75us/euro, and the forward rate equals .60us/euro, would we say the forward rate is at a discount for the US (domestic country)? Thanks guys.
For 1. All rates are to be taken as DC/FC. For 2: I believe yes. (0.60-.75) / 0.60 * 360/T (or 12/T) = discount rate annualized.
Woulnt we say that the forward rate is at a premium for US and discount for euro since in the future we will get less dollars per euro
I get totally confused in these questions. I think you are right.
A Euro buys 75 cents today but only 60 cents tomorrow. That means from the perspective of the Euro the dollar is at a forward premium. Which mean the Euro is at a forward discount to the dollar. Think eggs not currency. If $1 buys 75 eggs today but only 60 eggs tomorrow then eggs are at a forward premium. If it buys 80 eggs tomorrow they are at a forward discount.
Thanks Joey for the explanation the terminology and use of DC/FC and FC/DC interchangably throws me off course
this is what i use to remember - if forward is more than spot quoted as DC/FC, then “FC” is at premium and vice versa.