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FM Chapter 23 Questions – Foreign exchange risk management

 

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  1. According to my understainding of question 2 my answer is the following. What am I doing incorrect? Thanks in advance for your explanation.

    To calculate the 6-month forward exchange rate, we can use the interest rate parity formula:

    F = S * (1 + r_h)^n / (1 + r_f)^n

    where F is the forward exchange rate, S is the spot exchange rate, r_h is the home country interest rate, r_f is the foreign country interest rate, and n is the time until the forward exchange rate.

    Plugging in the given information, we get:

    S = 20 dinar/$
    r_h = 3%
    r_f = 7%
    n = 6 months = 0.5 years

    Now, we can use the interest rate parity formula to calculate the forward exchange rate:

    F = S * (1 + r_h)^n / (1 + r_f)^n
    = 20 * (1 + 0.03)^0.5 / (1 + 0.07)^0.5
    = 19.6489 dinar/$

    Therefore, the 6-month forward exchange rate is 19.6489 dinar/$.

    • For this formula, if the interest is 3% per annum, then for six months it is 3/2 = 1.5%.

      (You can see workings for all the questions if you click ‘review quiz’ after submitting your answers.)

  4. Hi Sir,
    For question 1, I calculated 12 month forward exchange rate is 1.418 euro per 1$ by using the formula. But I don’t understand the question clearly. The Q is “Compared to making a dollar investment for 12 months, at what 12 month Forward exchange rate will the investor make neither a loss or a gain?”. I am wondering if 12 month forward exchange rate (resulted in as 1.418 Eu per 1$) is the Spot rate on the date of the end of 12 month period? How can we predict the spot rate on a specific date in 12 months? How can we know we don’t make neither a loss nor a gain when we use this 12 month forward exchange rate? Please advise!!! Thank you so much!!!

  7. Hello Mr. Moffat,

    Could you please clarify this for me. On question 5, I get your POV that says if the euro has strengthened, it means you get more dollars for 1 Euro.

    But is it also not the case that if the Euro has strengthened by 20%, you only need 80% of it to get a dollar. That is currently the spot is equivalent to €/$ 0.5. So 20% stronger gives €/$ 0.4, hence the total receivable becomes 1000*0.4=$400?

    Thanks

      • You cannot have both of them strengthening!!

        Currently €1 buys $2.
        If the € strengthens by 20%, then 1 € will buy 20% more $’s. Therefore the new exchange rate will be such that €1 buys $2.40.

      • Hello Sir.
        I am asking if is there a difference between the exchange rate of R13.50/$,becasue if i appreciate the rand,say to R10.30/$,the rules that the export must be expensive in foreign country(as in your example) does not hold,please help.maybe I appreciate it in a wrong way.

      • Assuming we are in the country that uses the Rand and are exporting to a country using the $, then exports certainly do become more expensive.

        Suppose you export something for R100 to America. At the moment, the cost in $’s is 100/13.50 = $7.41.

        If the exchange rate changes to R10.30/$, then the cost in $’s increases and becomes 100/10.30 = $9.71

  8. Hi John, Just a doubt in q2 why we are using the interest rate parity to calculate the forward rate rather than purchasing power parity since both interest and inflatin rates are mentioned in the question. Thank You

  10. sir may you explain question 2??

    Why we are using both interest rate rather then one inflation of foreign country and interest of foriegn country.??

    We are using both interest rate.??

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