Question

The forward foreign exchange rate A. Determines the future spot exchange rate. B. Is unaffected by...

The forward foreign exchange rate

A. Determines the future spot exchange rate.

B. Is unaffected by changes in interest rates.

C. Is the ratio of equivalent spot amounts in each currency compounded to the forward maturity at the respective currencies' spot rates.

D. Is the rate that ensures that future expected purchasing power will be in parity.

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Answer #1

Answer is D. It is the rate that ensures that future expected purchasing power will be in parity.

A forward rate serves as an economic indicator of how market expects the future prices to change. So the business or investors who have information on how prices will move will use the forward rates. Forward exchange rate is a function of relative interest rates of two currencies. The forward exchange rate depends on three variables- spot exchange rate, domestic interest rate and foreign interest rate.

Thus, forward exchange rate can be used to lock in a currency rate in anticipation of its increase at some point in future and helps manage risk of currency fluctuations.

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