Question

Scenario 1:

You have to estimate the expected exchange rates between your home currency and the other currencies of the major other countries that you deal with in terms of both imports and exports. The reason is that increases in the values of other currencies compared to the U.S. Dollar may impact your imports negatively, whilst it may on the other hand, be good for exports. To do this estimate, you obtain the following spot exchange rate information:

£/$	0.76918
AUD$/$	1.38140

You also obtain the following annual risk free rates applying in the countries:

U.S.A.	2.660%
Britain	0.778%
Australia	1.953%

Your focus is presently to estimate the 3 month forward rates in order to consider the impact that it will have on the import and export sales of the company. Calculate the forward rates of the $ in terms of all the currencies by using simple interest rate parity e.g. 10% annual interest rate = 10/2 = 5% for six months. Do not effective annual interest rate compounding. Show all your workings in table 1 on the separate answer sheet by using the correct formula provided in your formula sheet.

Provide an indication about what will happen to the value of the US$ based on the forward exchange rate calculations by calculating the expected discount/premium of it for each of the currencies in Table 2 on the separate answer sheet. Also show whether the impact will be positive (P) or negative (N) for imports and exports. For example:

Exchange rate	% Discount/Premium	Import	Export
£/$	Workings by you ……………. = 1.93% premium	Positive	Negative

Answer 1

First to calculate 3month forward rate we need to change all interest rate for 3months;

USA = 2.66% *3/12 = 0.665%

Britain = 0.778% *3/12 = 0.1945%

Australia = 1.953% *3/12 = 0.48825%

Calculation of 3month forward rate by using interest rate parity;

£/$ = Spot rate * (1+£ interest rate)/(1+$ interest rate)

= 0.76918 * (1+0.001945)/(1+0.00665)

= 0.76918 * (1.001945)/(1.00665)

= 0.76558

Aus$/$ = Spot rate * (1+Aus$ interest rate)/(1+$ interest rate)

= 1.3814 * (1+0.0048825)/(1+0.00665)

= 1.3814 * (1.0048825)/(1.00665)

= 1.37897

Part 2) Calculation of discount rate for £/$

Discount rate = [(Forward rate - Spot rate)/Spot rate]*100*12/3

= [(0.76558-0.76918)/0.76918]*400

= (0.0036/0.76918)*400

= 1.44/0.76918

= 1.87%per annum

Calculation of discount rate for Aus$/$

Discount rate = [(Forward rate - Spot rate)/Spot rate]*100*12/3

= [(1.37897-1.3814)/1.3814]*400

= (0.00243/1.3814)*400

= 0.972/1.3814

= 0.7% per annum

Exchange rate	% Discount	Import	Export
£/$	1.87%	Negative	Positive
Aus$/$	0.70%	Negative	Positive