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Dear all,
I am confused about the type of exchange rate quoted, when I tried to use IRP to calculate Forward exchange rate:
F= S* ( 1+ i oversea)/ (1+ i domestic), S – spot rate should be direct quote or indirect quote?
Thanks!
Thanks. Yes, the examiner said that currencies in the exam will be quoted as indirect quotes. But BPP text book( 2011)gave some examples, which seem not follow formula. please see Page: 423 – example 3.4.1 and 3.5.1
3.4.1:
A US company is expecting to receive Kuwaiti dinars in one year’s time, the spot rate is US dollar/dinar 5.4670. The comany could borrow in dinars at 9% or in dollars at 14%.Prodict what the forward rate:
The anwer was given:Forward rate= 5.4670*( 1.14/1.09)
Who can explain if it is correct?
Easiest way to work this out is by being consistent.
In the formula you have quoted above in your first comment, overseas inflation rate is taken in the numerator, whereas domestic inflation rate is used in the denominator.
Therefore, the spot you use should be quoted as Overseas/Domestic.
Compare this to the bpp solution you have given above. The rate was given as US dollar/dinar. Therefore, this rate is divided by (1+US rate)/(1+dinar rate). Note how US dollar and US rate both come in the numerator, and how the dinar and dinar rate come down in the denominator. You should be consistent when multiplying the two; like with like.
Hope this helped.
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