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No forward rate is given for 5 months in question and it calculated based on 3 months forward rate and 1 year forward rate. However I didn’t understand why 3 months forward rate is multiplied by 7/9 and 1 year by 2/9 and added together to get 5 months rate. Thank you in advance. ( 3 months rate = 1.9066, 5 months=1.8901)
Answer is 1.9029
( I did not understand multiplier)I do not have the Kaplan Kit (only the BPP Revision Kit) but I think I can guess the question you are referring to because it happened in a past exam question.
What the examiner has done is correct, but it is a confusing way of doing it!!
Less confusing is the following:
There are 9 months between 3 months and 12 months.
So, assuming the rate was to change linearly, then the 5 month rate will be the 3 month rate plus 2/9 of the difference between the 3 and 12 month rate (because there is 2 month between 3 and 5 months).
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Dear John thank you. Question is Exchange rates: $/£
Spot 1.9156- 1.9210
3 months forward rate 1.9156-1.9210
12 months forward rate 1.8901-1.8945
We are paying USA supplier $1,150,000.00 in 5 months time, so forward market hedge for 5 months.
Solutions:
(1.9966*7/9)+(1.8901*2/9)=1.9029
( Lammer PLC Jun 06 Adapted)Lammer is the question I was thinking of, and what I wrote before is still correct and should be more obvious.
(You have copied the question wrongly – the 3 month forward rate is 1.9066 – 1.9120 (what you have typed it the current spot rate))
The estimate for 5 months is 1.9066 + 2/9(1.8901 – 1.9066) = 1.9029, which is the same as the examiners answer.
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Thank you very much John for prompt response.
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