Question

How are the forward rates between two currencies derived?

How are the forward rates between two currencies derived?

Homework Answers

Answer #1

Forward exchange rate is a rate at which a contract is to be executed in future at a predetermined exchange rate. Forward exchange rate is derived with the help of spot rate and interest rates in the countries of the two currencies involved in a forward contract.

Therefore forward rate is calculated usin the spot rates and interest rates using the following formula:

Above, F is the Forward rate,

S is the spot rate,

rd is the domestic currency interest rates

rf if the foreign currency interest rates

For example, if the spot rate of CAD/USD is 1.112 and interest rate on CAD and USD is 0.6% and 0.4% annualy, then calculate the 3 month forward rate on CAD/USD.

F= 1.11255

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