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Dear Lisa,
Please assist me with this:
In Example 4 of Chapter 23 of the OpenTuition eBook, the exchange rates are quoted as:
Spot $/£ 1.5326 – 1.5385
3m forward 0.62 – 0.51 c pm“pm” means premium – meaning the $ gets stronger, so £1 can only buy fewer dollars which means we SUBTRACT to get the 3m forward rate
MY QUESTION IS:
What difference will it make if, for example, the exchange rate is quoted as:
Spot £/$ 1.5326 – 1.5385
3m forward 0.62 – 0.51 c pm
(Please note: £ 1.5 = $ 1)Does this also mean the pounds get stronger so we SUBTRACT to get the 3m forward?
If the ER is quoted as Spot £/$ 1.5326 – 1.5385 with a 3m forward of 0.62 – 0.51 c pm, so yes it indicates that the forward rate is quoted in terms of pounds per dollar.
So if the forward is at a premium, it means that the dollar is expected to strengthen against the pound. Therefore, you would still subtract the forward premium to calculate the 3m forward rate.
So in answer ……Yes , if the pounds are getting stronger, you would subtract the premium to determine the forward rate, similar to the original example where the dollar was quoted against the pound.
Ok, Lisa.
Thank you.But just for certainty: If the forward rate is quoted at a premium, the SECOND currency is quoted against that appreciates?
Example 1:
Spot $/£ 1.5326 – 1.5385
3m forward 0.62 – 0.51 c pm
Here, the pounds (£) appreciatesExample 2:
Spot $/€ 1.5326 – 1.5385
3m forward 0.62 – 0.51 c pm
Here, the euro (€) appreciates.If the forward rate is quoted at a premium, it indicates that the first currency (in this case, the dollar) is expected to strengthen against the second currency (the pound or euro).
So when the forward rate is at a premium, it is the second currency that is depreciating in value relative to the first currency.
In your examples, if the forward rate is quoted at a premium, it means that the dollar appreciates against the pound or euro.
John makes this clear in his video on forward ct
Don’t get into the scenario of what if’s, keep to the exam standards…. In summary, an examiner has an exam to write section A-C style questions.
The exam is to make sure it’s good coverage of the syllabus as a whole. It is to test candidates ability, understanding and to see if they know enough, are technically competent and can deal with the stress of an exam. Not to trick you!That’s an invaluable piece of advice.
Thanks a lot, Lisa.
The concept is fully understood. 🙂
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