Sei sulla pagina 1di 26

Forward Rate

If the exchange of currencies takes place after a certain period from the date of the deal (more than two working days), it is called the forward rate. Quotations for forward rates can be expressed in two ways: i. They can be made in terms of the exact amount of local currency at which the trade quoting the rates will buy and sell a unit of foreign currency. This is called the outright rate.

ii. In the inter bank market dealers quote the forward rate only as a discount from or premium on, the spot rate. This forward differential is known as the SWAP RATE. A foreign currency is at a forward discount if the forward rate is below the spot rate where as a forward premium exits is the forward rate is above the spot rate.

For example, spot Japanese yen on Fell.6,1990,sold at $0.006879 while 90-day forward yen were price at $0.006902. Based on these rates,the swap rate for the 90 day forward yen was quoted as a 23 point premium (0.006902-0.006879.similarly,because the 90 days British pound was quoted at $ 1.6745 while the spot pound was $ 1.7015,the 90-day forward British pound sold at a 270-point discount. Alternatively, the discount or premium may be expressed as an annualized percentage divertive from the spot rate using the formula :
Forward premium Or discount = forward rate spot rate 12 spot rate forward contract lefty is months

Thus on 6-2-1990,the three-m with forward yen was selling at a 1.34 90 annualized premium :

Forward premium
Annualized

=
=

0.006902-0.006879
0.006879

12 =
3 0.0134

British f- 3 month was selling 6.35% discount

Forward discount
Annualized =

1.6745-1.7015
1.7015

12 = - 0.0635
3 = 6.35% annualized discount

The forward rates can also be quoted in terms of points of premium or discount on the spot rate which is used in inter bank quotations. To find to outright forward rates when premium or discount on quotes of forward rates are given in terms of points the points are added to the spot rate if the foreign currency is trading at a premium; the points are cultivated from the spot price if the foreign currency is trading at a forward discount .

Whether the quotes in points represent a premium or discount on the spot rate can be casing determined .if the first forward quote (the bid buying figure) is smaller than the send forward quote (the offer or the asking or selling figure), then there is a premium. In such a situation points are added to the spot rate converses of the first quote is greater than the second then it is discount.
If the dealer , both the figure are the same then the dealer has to specify whether the forward rate is at premium or discount this procedure ensure that the buy price is lower than the sell price and the trader benefits from spread between the two prices. Example :

spot 1. Month 3 month 6.month


Ff/us $ s.2321/2340 25/20 40/32 20/26

In outright terms these quote would be expressed as under :

Majority Spot

Bid/Buy

Sell/Offer/Ask

Spread 0.0019

FFr 5.2321/$ FFr 5.2340/$

1-month
3-month 6-month

5.2296/$
5.2281/$ 5.2341/$

5.2320/$
5.2308/$ 5.2366/$

0.0024
0.0027 0.0025

It may be noted that in the case of 1 month and 3 month , US dollar is at discount against Francs farce while 6 month forward is at premium. The first figure is greater than the second both in 1 month and 3 month forward quotes.therefore, these quote are at a discount and accordingly these points have been cultivated from the spot rates to arrive at outright rates. The reverse is the case for 6 month forward .

Forward Rate and Interest Rate


If there are no controls on capital flow. The interest rate differential between two currencies is the most dominant factor in determining the forward points this is based on simple logic of trade off between interest earned on one currency and opportunity foregone to earn interest on another currency. Example : Forward differential points

Spot us $ 1= DM 1.5000
Interest, us $ @ 30% PA, DM @ 6% PA Suppose a person borrows us $ 100 for only year

@ 3% PA; converts into DM and places same as deposit for 1 year @ 6 % this CASHFLOW

US $

DM

Inflow Outflow Inflow Outflow Spot borrows Sells $ Interest-one year price Total Sells DM-one year here @ 1.50 +106 - 159 +100 -100 -3 -103 +150 +9 + 159

Net gain

us $ 3

And after one year converting Damaging into US $ . However ,it is being presumed that US $ /DM rate continue to be same for spot and 1 year forward.

The person having DM would not like to give this opportunity. The cortically speaking the returns on both the currencies will be the same and forward exchange rate of US $/OM will be adjusted by market forces to eliminate any arbitrage opportunity the US $/DM rate will be
US $ 103 = 159 US $ 1 = 103 = DM 1.5436

Thus 0.0436 represents the forward differential between spot and one year forward. This differential is determined by the interest rate differential between the two currencies.
Interest parity principle holds good only in a market which is free to determine exchange and interest rates purely by demand and supply. India exchange control does not permit banks in India to borrow or make time deposits in foreign currency, the freedom to do

which is at the heart of interest parity .


Form the way in which dealers prices their quotations and hedge their forwards it is clear that forward rate are priced in such a way as obey covered- interest parity. So the two sides of the have arbitrate transaction see the profit to zero. to illustrate say India rupee was trading spot at 43.50 /$. There-month rates were 6.5 % (PA) for the dollar and 12.5 % for the rupee. The forward rate will be as under : 1+ .125 4 43.5 1+ .065 4 = 44.14

The forward rate can be seen as describing the fundamental way in which that rate more than the spot rate with as adjustment for relative interest rate.
Although the interest rate seams to be the most important factors, it is actually the spot rate that is the dominant factor.the spot rate fluctuate for more reds calmly than does the adjustment for the intersect rate differential the later called the SWAP POINTS by dealers is the forward premium or discount when expressed as annualized percentage.

Forward Exchange Rate The forward rate is the rate quoted by fore dealers for the purchase or sale of fore in the future. The difference between the spot rate and the forward rate is known as the spread in the forward market . The differences between the spot and forward rates rate a 90days contract for the Canadian dollar and the Japanese Yen , quoted in terms of US $ is as follows : Cent $ Spot 90-days forward points $0.8576 0.8500 -76 JP y $0.007541 0.007543 +2

The spread in can $ is 76 points ; since the forward rate is less than spot rate the can .$ is at a discount in the 90 days forward market. The spared in JPY is only 2 points and since the forward rate is more than the spot rate, the Yen is at a Premium in the forward market.

The premium or discount can also be quoted in terms of annualized be cont, as follows ;
Premium (discount) = forward rate spot rate x 12 x 100

spot rate
N is the no. of months forward. Discount = 0.8500-0.8576 x 12 x 100 = 3.54 % 0.8576 3

Which means that can . $ is selling at a discount of 3.54 percent under the spot rate.

Exercise 1. A fore dealer quoted the following rates for the pounds sterling on Friday nor.30,1995.

Spot
30 day forward 90 day forward 180 day forward

$ 1.4710/$ 1.4810
65/44 145/123 290/222

(a) Determine the outright quotations for the pound sterling. (b) Was the pound sterling selling at a forward premium or a forward discount on that date ? Calculate the forward premium (or discount) on the 90-day forward contract use ask (offer) rate to answer this question.

How many US dollars would it cost you to buy f 1,000,000 on no.30,95 ?


(d) If you expect to receive f 1000,000 in 180 days from the quotation date how many US dollars would you expect to realize by selling then forward ? (e) Assuming that the yield on a six month CD of major banks in USA is 9 % , what should be the yield on a comparable CD in Unto ensure interest parity between the two countries ? 1. Ans (a) Spot / 30 day f 90 day-f 180 day forward

Bid/ask

Bid/Ask

Bid/Ask

Bid Ask

$ 1.4710/1.4810 1.4645/1.4766 1.4565/1.4687 1.4420/1.4588

(d) At a forward discount swap points are in descending order and must therefore be distracted from the spot rate to obtain the outright forward quotations.
1,000,000 x1.4810 (d) 1,00,00 x 1.4420 (e) Forward premium (discount) =

1.4588-1.4810 x 12 x 100
1.4810 6 = - 3.00 %

The yield on a UK CD should be 12 % pa.

Forward Contracts A forward contract between a bank and a customer (which could be another bank) calls for delivery at a fixed future date of a specified amount of one currency against dollar payment; the exchange rate is fixed at the time the contract is entered nits. For example a US company buys textiles from England with payment of f 1 million due in 90 days. The importer, thus is SHORT POUNDS, that is it owes pounds for future delivery. Suppose the present price of the pounds is $ 1.71. Over the next 90 days , however the pound might rise against the dollar, raising the dollar cost of the textiles. The importer can guard against this exchange risk by immediately negotiating a 90 day forward contract with a bank at a price of say f = $ 1.72. According to the forward contract in 90 days the bank will give the importer e 1 million (which it will use to pay for its textile rate). and the importer will give the bank $ 1.72 million which is the dollor .

Equivalent of f 1 million at the forward rate $ 1.72.


in technical terms the importer is offsetting a short posting in pounds by going long in the forward market that is by buying pounds for future delivery.

The gain and losses from long and short forward position are related to the difference between the contracted forward prices and the spot price of the underlying currency at the time the contract mature . In the case of textile order, the importer is committed to buy pounds at $1.72 a price.if the spot rate in 90 days is less than $ 1.72, the importer will suffer a loss on the forward contract because he is buying pounds for more than its prevailing value. But if the spot rate in 90 days exceeds $ 1.72, the importer will enjoy an implicit profit because the contract obliges the bank to sell the pounds at a prices less than its current value.

Important : First, the gain or loss on the forward market is unrelated to the current spot rate. Second, the forward contract game or loss currency offset the change in the dolor cost of the textile order that is associated with movements in the pounds value.for example if the spot price of the pound in 90 days is $ 1.75, the importer cost of delivery is $ 1.75 million . However, the forward contract has a gain of $ 80,000 or 1,000,000 x (1.75-1.72) the net cost of the textile order when covering with a forward contract is $ 1.72 million no matter what happens to the spot rate in 90 days. Third the forward contract is not an options contract both paints must perform the agreed upon behavior, unlike the situation with an option where the buyer can chose whether top exercise the contract or allow it to expire.the bank must deliver the pounds and the importer must buy them at the pre arranged price.

Forward Market Participants


Arbitrageurs seek to earn risk free profit by taking advantage of differences in interest rates among countries. They use forward contracts to eliminate the exchange risk involved in transferring transferring their funds from one nation to another. Traders use forward contracts to eliminate or cover the risk of loss on export or import order that are denominated in foreign currencies. More generally a forward covering transition relates to a specific payment or receipt expected at a specific point of time.

Hedgers mostly MNCS engage in forward contracts to protect the home currency value of various foreign currency denominated asset & liabilities on their balance sheets.

Arbitrageurs, traders and heeders seek to reduce (or eliminate, if possible) their exchange risks by Locking in the exchange rate on future trade or financial operation. Speculates, however, actively expose them selves to currency risk by buying or selling currencies forward in order to profit from exchange rate fluctuation. Their degree of paints inpatient is based on prevailing forward rates and their expectation for spot exchange rate in the future.

ii. The national principal am hedge should not exceed the amount of the foreign currency loan.
Payment of all charges incidental to the transition can be made without the prior approval of the RB. iv. The customers bank should ensure that the hedge transitions are done safely for liability management and obtain an under taking from the customer that the same exposure has not been covered with any

v. The bank should scrutinize the original document and retain a copy for malting endorsement.
iv. The Board of directors of the company should have approved the financial limits and authorized official toy enclosed the hedge transitions. vii. A report of the transaction completed and audit certification of compliance with rate are to be unlimited to the RBI in due course.

Forward Contracts In India Appropriately only those who have a transactional need can access the fore market in India current rules,therefore restrict access to hedging instrument like forward contracts to companies who have exposures due to trade or financial transaction. The customers bank is responsible for ensuring that the exposure are genuine . RBI introduced changes in august 96 in this regard .till July 96,firms had to get approval on a case hazes from the ministry of finance buying an interest rate hedging product.the RDI has now allowed banks to offer. Interest rate swaps , currency swaps ,

Interest rate agreements,


forward rate agreements ,

To companies with out prior approval of the Govt/RBI. They can also unwind the hedge without prior approval.
the authorised dealer should ensure that i. The RDI has allowed the underlying transaction.

Forward Dollar Rate In India Like the spot dollar : rupee rate the forward rate too is basically a function of demand and supply. Under India exchange control non bank entities can sell or purchase foreign currencies in the forward market through the ADS only when they have an underlying contractual commercial exposure,e.g. an import transaction.

Again not only do banks have to keep open position within approved limits,that they are ales required to ensure that there is no under mismatch of maturities in their forward transitions.
For example, a contract for purchase of January dolor from a customer should in general be covert by sale of those dollars for delivery in January.

The RDI calls for periodical report in order to ensure that thus, with these changes,delays in asking for permission are eliminated the cos. Can now ask for quotation and respond to them immediately. As payments due under the hedging instruments can be made without the RDI permission , there will be no delay on this count. The firms are now obliged to go through AD/S & not only on foreign blank as before.

Change made place great confidence on the co. its official, ADS & the auditions . The original document will no camper be retained and stamped by the ADS but only certified copies endorsed with details of for ward countries entered into.
Thus the cos. Are expected to be genuine & not made in fours with make underlying documents. Some basic rules and a lot of trust. Homely the game will be played as it should be.mismatches of forward contracts are within limits.

Thus the basic demand and supply is generated by the corporate world demand from importers and borrowers of foreign currencies(for interest and repayment obligations) and supply from exporters. Under the FCNR(B) scheme, blank can swap foreign currency deposit for rupees only in the market . Thus the deposited banks are also a source of demands in the forward market. The forward margin therefore, fluctuates widely, depending on the perceptions of the buyers and sellers of currencies.