Question

(i) Distinguish between spot and forward foreign exchange transactions.

      (ii) Describe how are spot and forward quoted in the foreign exchange market.

      (iii) Andreas Broszio just started as an analyst for Credit Suisse in Zurich, Switzerland. He receives the following quotes for Swiss francs against the dollar for spot, one-month forward, 3-months forward, and 6-months forward. 10+15

Spot exchange rate:
Bid rate	SF 1.3075/$
Ask rate	SF 1.3085/S
One-month forward	15 to 20
3-months forward	16 to 25
6-months forward	20 to 35

1. Calculate outright quotes for bid and ask rates, and the spread between bid and ask rates.
2. Compute premium/discount on the Swiss franc for each maturity using the average spot and the average forward rate.

Answer 1

i]

In a spot transaction, the currencies are exchanged immediately at the current rate. In a forward foreign exchange transaction, the currencies are exchanged in the future at specified date and at a specified rate.

ii]

Spot rates are quoted with one currency being the base currency and the other being the quote currency.

Forward rates are quoted as a premium or discount on the spot rate

iii]

a]

One-month forward bid = 1.3075 + 15 = 1.3090

One-month forward ask = 1.3085 + 20 = 1.3105

spread = 1.3105 - 1.3090 = 0.0015

3-month forward bid = 1.3075 + 16 = 1.3091

3-month forward ask = 1.3085 + 25 = 1.3110

spread = 1.3110 - 1.3091 = 0.0019

6-month forward bid = 1.3075 + 20 = 1.3095

6-month forward ask = 1.3085 + 35 = 1.3120

spread = 1.3120 - 1.3095 = 0.0025

b]

Average spot rate = (bid + ask) / 2 = (1.3075 + 1.3085) / 2 = 1.3080

One-month average forward rate = (1.3090 + 1.3105) / 2 = 1.30975

premium = 1.30975 - 1.3080 = 17.5

3-month average forward rate = (1.3091 + 1.3110) / 2 = 1.31005

premium = 1.31005 - 1.3080 = 20.5

6-month average forward rate = (1.3095 + 1.3120) / 2 = 1.31075

premium = 1.31005 - 1.3080 = 27.5