 # Spot Rate - Forward Rate (ques)

The spot rate on New Zealand dollar (NZD) is 1.4286 NZD/USD, and the 180-day forward rate is 1.3889 NZD/USD. This Difference means: A. Interest Rates must be lower in the US than in NZ B. Interest Rates must be higher in the US than in NZ C. NZD is expected to depreciate D. USD is expected to appreciate - Dinesh S

Can’t be C or D…

perfect, that is where I stopped, left with just ‘A’ and ‘B’. - Dinesh S

well…my first thought was the equation for figuring out forward rates… Forward NZD/USD = Spot NZD/USD * [(1+rNZD)^t/ (1+rUS)^t] The division of interest rates would have to be less than one for the equation to work, meaning rates in the US are higher. I would go with B…

I would go the other way round… For the Interest Rate Partiy to be true, the following equation needs to be satisfied (Forward Rate NZD/USD) / (Spot Rate NZD/USD) = (1+ rNZD)/ (1 + rUSD) Given data, Forward Rate NZD/USD = 1.3889 Spot Rate NZD/USD = 1.4286 LHS = 1.3889/1.4286 = 0.9722 i.e LHS < 1 So for the RHS to be also < 1 (1+ rNZD)/ (1 + rUSD) < 1 (1+ rNZD) < (1 + rUSD) rNZD < rUSD So proved that interest rates are higher in USA than in NZ. Please let me know if this reasoning is correct? - Dinesh S

you set it up like a linear programming problem…hahaha…(sorry I have a grad school class with that stuff right now) makes sense to me…thanks for the insight

mutualfundsig Wrote: ------------------------------------------------------- > well…my first thought was the equation for > figuring out forward rates… > > Forward NZD/USD = Spot NZD/USD * [(1+rNZD)^t/ > (1+rUS)^t] > > The division of interest rates would have to be > less than one for the equation to work, meaning > rates in the US are higher. > > I would go with B… Your way works too of course. Forward NZD/USD = Spot NZD/USD * [(1+rNZD)^t/ (1+rUS)^t] 1.3889 = 1.4286 (X) X therefore has to be less than one…so US rates are higher.

TRUE!!!

mutualfundsig Wrote: ------------------------------------------------------- > you set it up like a linear programming > problem…hahaha…(sorry I have a grad school > class with that stuff right now) …and guess what, I have a bachelors in Computer Engineering … hahaha. Anyway’s, no pun intended, I have to go to such minutia to understand even the basics - Dinesh S

that’s great…we seem to be hitting on the same threads too…

You don’t do proofs for this kind of thing. 1) Let’s see. 1.4 NZD/US -> 1.3 NZD/USD. Think 1.4 eggs/USD -> 1.3 eggs/USD => eggs, uh, NZD are getting more expensive, i.e., NZD appreciating. 2) Currencies are expected to appreciate when their interest rates are low which is why I can’t arbitrage the world. => B is the right answer. BTW - Linear programming is about optimization under constraints which has nothing to do with any of this.

Thanks for your eve expanding insight and simplification of the problems. I realize what linear programming is. His reference to LHS and RHS constraints reminded me of linear programming. Sorry to ruffle your feathers.

There are many problems lilke this on the actual exam. The math on the exam isn’t really that hard but the concept needs to be applied. In this case you knew the formula so you should be able to figure out any answer given just a few variables. Make sure to take a couple of CFAI practice tests…you will see how different they are from Schweser (my experience).

mutualfundsig Wrote: ------------------------------------------------------- > Thanks for your eve expanding insight and > simplification of the problems. > I realize what linear programming is. His > reference to LHS and RHS constraints reminded me > of linear programming. Sorry to ruffle your > feathers. You didn’t ruffle my feathers; I’m just naturally cranky. Comes from age. I think linear programming is very neat.