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The home currency of ACB Co is the dollar and it trades with a company in a foreign country whose home currency is the Dinar. The following information is available:
/………………………………………Home Country …………………………..Foreign Country
Spot rate …………………………20.00 dinar per $
Interest rate …………………….3% per year ……………………………….7% per year ..
Inflation rate …………………….2% per year ………………………………5% per yearWhat is the six month forward exchange rate? ..
BPP explains that forward rates are calculated by using interest rate parity.I don’t understand what is the difference between future rate and forward rate. I don’t know whether I should used interest rate parity or purchasing power parity when calculate these rates.
You have written the answer yourself 🙂
Forward rates are rates quoted now to apply on a fixed future date. They are always determined by the relative interest rates of the two countries, and are calculated using interest rate parity.
If, on the other hand, you are asked to forecast what the actual spot rate is likely to be in the future, then we use purchasing power parity (i.e. the relative inflation rates).
I do suggest that you watch the free lecture on foreign exchange, and foreign exchange risk management.
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