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for example 3 u said we are buying $ won”t the bank sell to us at the highest of the rates i.e 1.4970 and not 1.4910?
No – think about it.
If we are buying (say) $100,000, then if we convert at the higher rate it will only cost us £66800. If we convert at the lower rate it will cost us £67069.
The reason for the two rates is that the difference is the banks ‘profit’ and so it has to be whichever rate is worse for us. Since we are having to pay £’s, it is whichever ends up with us having to pay the most £’s
I am gonna clear this exam this time for sure with the help of these lectures…thanks alot…
i found one point confused.
in your example 5, “chapter: foreign exchange risk management”, the amount Z will pay using the forward buying rate of 1.6665 cuz we have to buy $200,000 from bank before we pay it.(the question is , in order to buy $ from bank, we have to sell pounds to the bank then get the $, so why not using the selling rate of 1.6715 as the similar situation illustrated in example2 in the note?)
many thanks, your lecture is so clear! thank you again. hope to hear from you soon.
Cjm32228 In the example 5, Z needs to buy the 1st currency (which is $) from the bank. So we use the buying rate 1.6665.
In the example 2 Jimjam is in India and he has to sell Indian Rupees in order to buy Ruritanian Dollars and Indian rupee is the 1st currency again. So we used the Selling rate.
You have to decide are you buying or selling FIRST CURRENCY, keyword is the “first currency”.
Dear Mr. John Moffat,
Thank you for prompt reply. Your reply had made the concept very clear. Once again thank you very much.
You have got the idea, but be careful.
In your example in the last paragraph, the SLR is quoted against the USD. (SLR/USD 109).
If the forward rate it quoted pm, it means that they are quoting the SLR at a premium (because the spot rate is quoted SLR to 1 USD). If the SLR is quoted at a premium it means that the SLR is to strengthen and therefore fewer SLR’s to the USD – you would subtract the premium.
The way spot rates are quoted in the exam is always how many of the first currency = 1 of the second. (e.g. SLR/USD 109 means 109 SLR = 1 USD). When the forward rate is quoted as pm or dis then it is always the first currency that is strengthening (pm) or weakening (dis) and so you always subtract a pm and add a dis.
Can you please confirm if the value of the domestic currency in relation to that of the foreign currency plays a crucial role in calculation of forward rate given a premium/discount rate?
As mentioned in the lecture, pm stands for premium meaning the forward rate is at a premium i.e the foreign currency is expected to appreciate in value in the future. Therefore, depending on whether the domestic currency appreciates (increases in value) or depreciates (decreases in value) in relation to the foreign currency, the premium is deducted or added, respectively. Is my understanding correct?
In our examples 4 & 5, the GBP (local/domestic currency) is at a higher value than the USD (foreign currency). So if anticipating that the GBP were to appreciate further in 3 months, the US dollars forward rate would be set at a discount to the spot rate. If anticipating that the GBP were to depreciate in 3 months, the US dollar forward rate would be at a premium.
If suppose we were transacting in Sri Lankan Rupee where, where 1 USD = SLR 109, the domestic currency (SLR) is at a lower rate than the USD (foreign currency). In this situation would we add the premium to the SLR assuming that the foreign currency appreciates in 3 months and deduct the discount assuming that the foreign currency depreciates?
Looking forward to your reply.
These lectures are SO helpful! Thanks a lot!! =)
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