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i have learnt the technique by rote but please assist me how to use the forward exchange rate using formula in this context of swap as it looks different than what we have done using exchange rate.
Year 2 forward rate: (1·04252^2/1·037) – 1 = 4·80%
Year 3 forward rate: (1·04703^3/1·04252^2) – 1 = 5·61%
Year 4 forward rate: (1·05104^4/1·04703^3) – 1 = 6·31%
Rates are reduced by 20 basis points in calculation.These are not forward exchange rate – they are forward interest rates!!
The question is based on one of recent technical articles on the ACCA website.
If you borrow $100 for 2 years at the spot yield rate of 4.25% per year, then after 2 years you would end up owing 100 x (1.0425^2)
If you borrowed $100 for 2 years with the first year being at the spot yield rate for 1 year of 3.70%, and the second year being at a 2 year forward rate of r%, then after 2 years you would be owing:
$100 x 1.037 x (1+r)Therefore 1.037 x (1+r) = 1.0425^2
r = (1.0425^2 / 1.037) – 1 = 0.048 (or 4.80%)
It is the same workings for the other rates.
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