Question
In: Finance
What is meant by the three-month forward exchange rate?
What is meant by the three-month forward exchange rate?
Solutions
Expert Solution
* Forward exchange rate is used to represent the current expectations of future currency exchange rate.
* Three-month forward exchange rate refers to an exchange rate to which both the parties in a forward currency exchange contract agree to exchange one currency for another at a future date (three months from the day of contract initiation).
* These rates can be used by multinational companies to hedge their currency risk. Suppose a company expects a payment in foreign currency after 3 months, it may be vulnerable to fluctuations of currency within these 3 months. Hence it can enter into a forward contract (3 months maturity) and lock in a rate today to hedge it's position.
* Forward Exchange Rate can be determined using the interest rate parity condition. Let 'S' be the spot rate (domestic is the base currency, foreign currency being quoted), 'F' be the forward rate, id be the domestic interest rate & if be the interest rate of the foreign currency..
F = S * [1 + id * (t/360)]/[1 + is * (t/360)]
3 month forward rate (F) = S * [1 + id * (90/360)]/[1 + is * (90/360)]
jeff jeffy answered 1 year agoRelated Solutions
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