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Dear Sir,
With regard to the sample answer provided for 3 (a):
Forward market – Why the rate use is 1.5996 but not 1.6037? (I am on self-study, actually I am not sure how to interpret the these two rates, the front one and the latter one. Besides, is it that we always have to choose the lower one? As I noticed this is applicable to the answer for Money Market at latter part too – convert in to pound at spot US$2,381,543/1.5938, and also in the Option computation, seems to choose the front rate).
It makes no different whether we are talking about spot rates, forward rates or whatever.
The reason that there are two rates is that it depends which way you are converting the money (the difference is the banks ‘profit’).There are several ways you can remember which rate to choose. The way I remember is that the lower is the relevant rate if the company is buying the first currency (if it is, for example, a $/£ quote then the ‘first currency’ is $’s. Whereas if you are selling the first currency ($’s in this case) then you use the higher rate.
For a full explanation, you should watch my free lecture on this website.
Yes, I have watched your lectures. This topic is particularly confusing to me.
Let’s say quoted $/£, $1.35 – $1.37:
Is it that when you have a $ receipt due – you are selling the $, so will use $1.37; and
when you have a $ payment due – you are buying the $, so will use $1.35?Applicable to both spot and forward rates.
What you have written is correct 🙂
And, yes, it is the same rule for both spot and for forward rates – they are both quoted in the same way.
Thank you sir!
If you allow, I wish to ask about the call and put options here.
Let’s say quoted $/£:
Is it that when you have a $ receipt due – you buy call option; and
when you have a $ payment due – you buy put option?If quoted reversely £/$, then you will do the reverse, you buy put option for the $ receipt due and buy call option for the payment due.
What matters for options (and for futures) is the currency that the contract size is given in.
If we are in the UK and we need to pay $’s to a US supplier, the normally we want to buy $’s.
So if the contract size was in $’s we would buy call options (the right to buy $’s). However, more likely, the contract size will be in £’s, in which case we need to buy put options (the right to sell £’s which is what we want to do in order to get $’s).Best really is to watch my two free lectures on foreign exchange risk management.
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