Exact matches only

Search in title

Search in content

Filter by Categories

101 concepts level I

101 concepts level II

2021 Level I Corporate Finance Full Videos

2021 Level I Economics Full Videos

2021 Level I Ethics Full Videos

2021 Level I FRA Full Videos

2021 Level I Portfolio Management Full Videos

2021 Level I Quantitative Methods Full Videos

Advice and How to Study Videos

All-Levels

Alternative Investments

Alternative Investments (AI)

BookLet Top Level

Corporate Issuers

Corporate Issuers (CI)

Demystified Videos

Derivatives

Derivatives (DV)

Economics

Economics (EC)

Equity

Equity Investments (EI)

Ethical and Professional Standards (ES)

Ethics

featured

Financial Reporting and Analysis

Financial Statement Analysis (FSA)

Fixed Income

Fixed Income (FI)

Level I

Level II

Level III

LM01 Alternative Investment Features, Methods, and Structures

LM01 Categories, Characteristics, and Compensation Structures of Alternative Investments

LM01 Corporate Structures and Ownership

LM01 Derivative Instrument and Derivative Market Features

LM01 Ethics and Trust in the Investment Profession

LM01 Fixed-Income Instrument Features

LM01 Fixed-Income Securities: Defining Elements

LM01 Introduction to Financial Statement Analysis

LM01 Market Organization & Structure

LM01 Market Organization and Structure

LM01 Organizational Forms, Corporate Issuer Features, and Ownership

LM01 Portfolio Management Overview

LM01 Portfolio Management: An Overview

LM01 Rates and Returns

LM01 The Firm & Market Structures

LM01 Time Value of Money

LM01 Topics in Demand and Supply Analysis

LM02 Alternative Investment Performance and Returns

LM02 Analyzing Income Statements

LM02 Code of Ethics and Standards of Professional Conduct

LM02 Code of Ethics and Standards of Professional Conduct Profession

LM02 Financial Reporting Standards

LM02 Fixed Income Markets - Issuance Trading and Funding

LM02 Fixed-Income Cash Flows and Types

LM02 Forward Commitment and Contingent Claim Features and Instruments

LM02 Introduction to Corporate Governance and Other ESG Considerations

LM02 Investors and Other Stakeholders

LM02 Organizing, Visualizing, and Describing Data

LM02 Performance Calculation and Appraisal of Alternative Investments

LM02 Portfolio Risk & Return: Part I

LM02 Portfolio Risk and Return Part I

LM02 Security Market Indexes

LM02 The Firm and Market Structures

LM02 Time Value of Money in Finance

LM02 Understanding Business Cycles

LM03 Aggregate Output, Prices and Economic Growth

LM03 Analyzing Balance Sheets

LM03 Business Models & Risks

LM03 Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits

LM03 Derivative Benefits, Risks, and Issuer and Investor Uses

LM03 Fiscal Policy

LM03 Fixed-Income Issuance and Trading

LM03 Guidance for Standards I-VII

LM03 Guidance for Standards I–VII

LM03 Introduction to Fixed Income Valuation

LM03 Investments in Private Capital: Equity and Debt

LM03 Market Efficiency

LM03 Portfolio Risk & Return: Part II

LM03 Portfolio Risk and Return Part II

LM03 Private Capital, Real Estate, Infrastructure, Natural Resources, and Hedge Funds

LM03 Probability Concepts

LM03 Statistical Measures of Asset Returns

LM03 Understanding Income Statements

LM04 An Introduction to Asset-Backed Securities

LM04 Analyzing Statements of Cash Flows I

LM04 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

LM04 Basics of Portfolio Planning & Construction

LM04 Basics of Portfolio Planning and Construction

LM04 Capital Investments

LM04 Common Probability Distributions

LM04 Fixed-Income Markets for Corporate Issuers

LM04 Introduction to the Global Investment Performance Standards (GIPS)

LM04 Monetary Policy

LM04 Overview of Equity Securities

LM04 Probability Trees and Conditional Expectations

LM04 Real Estate and Infrastructure

LM04 Understanding Balance Sheets

LM04 Understanding Business Cycles

LM04 Working Capital and Liquidity.

LM05 Analyzing Statements of Cash Flows II

LM05 Capital Investments and Capital Allocation

LM05 Company Analysis: Past and Present

LM05 Fixed-Income Markets for Government Issuers

LM05 Introduction to Geopolitics

LM05 Introduction to Industry and Company Analysis

LM05 Monetary and Fiscal Policy

LM05 Natural Resources

LM05 Portfolio Mathematics

LM05 Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

LM05 Pricing and Valuation of Forward Contracts.

LM05 Sampling and Estimation

LM05 The Behavioral Biases of Individuals

LM05 Understanding Cash Flow Statements

LM05 Understanding Fixed-Income Risk and Return

LM05 Working Capital & Liquidity

LM06 Analysis of Inventories

LM06 Capital Structure

LM06 Cost of Capital-Foundational Topics

LM06 Equity Valuation: Concepts and Basic Tools

LM06 Financial Analysis Techniques

LM06 Fixed-Income Bond Valuation: Prices and Yields

LM06 Fundamentals of Credit Analysis

LM06 Hedge Funds

LM06 Hypothesis Testing

LM06 Industry and Competitive Analysis

LM06 International Trade

LM06 Introduction to Geopolitics

LM06 Introduction to Risk Management

LM06 Pricing and Valuation of Futures Contracts

LM06 Simulation Methods

LM07 Analysis of Long-Term Assets

LM07 Business Models

LM07 Capital Flows and the FX Market

LM07 Capital Structure

LM07 Company Analysis: Forecasting

LM07 Estimation and Inference

LM07 International Trade and Capital Flows

LM07 Introduction to Digital Assets

LM07 Introduction to Linear Regression

LM07 Inventories

LM07 Pricing and Valuation of Interest Rate and Other Swaps

LM07 Pricing and Valuation of Interest Rates and Other Swaps

LM07 Technical Analysis

LM07 Yield and Yield Spread Measures for Fixed-Rate Bonds.

LM08 Currency Exchange Rates

LM08 Equity Valuation: Concepts and Basic Tools

LM08 Exchange Rate Calculations

LM08 Fintech in Investment Management

LM08 Hypothesis Testing

LM08 Long Lived Assets

LM08 Measures of Leverage

LM08 Pricing and Valuation of Options

LM08 Topics in Long-Term Liabilities and Equity

LM08 Yield and Yield Spread Measures for Floating-Rate Instruments

LM09 Analysis of Income Taxes

LM09 Income Taxes

LM09 Option Replication Using Put-Call Parity

LM09 Option Replication Using Put–Call Parity

LM09 Parametric and Non-Parametric Tests of Independence

LM09 The Term Structure of Interest Rates: Spot, Par, and Forward Curves

LM10 Financial Reporting Quality

LM10 Interest Rate Risk and Return

LM10 Non-current (Long-Term) Liabilities

LM10 Simple Linear Regression

LM10 Valuing a Derivative Using a One-Period Binomial Model

LM11 Financial Analysis Techniques

LM11 Financial Reporting Quality

LM11 Introduction to Big Data Techniques

LM11 Yield-Based Bond Duration Measures and Properties

LM12 Applications of Financial Statement Analysis

LM12 Introduction to Financial Statement Modeling

LM12 Yield-Based Bond Convexity and Portfolio Properties

LM13 Curve-Based and Empirical Fixed-Income Risk Measures

LM14 Credit Risk

LM15 Credit Analysis for Government Issuers

LM16 Credit Analysis for Corporate Issuers

LM17 Fixed-Income Securitization

LM18 Asset-Backed Security (ABS) Instrument and Market Features

LM19 Mortgage-Backed Security (MBS) Instrument and Market Features

New Booklet Top level

Portfolio Management

Portfolio Management (PM)

Quantitative Methods

Quantitative Methods (QM)

Uncategorized

Please select your exam.

IFT Notes for Level I CFA^® Program

LM08 Currency Exchange Rates

Part 4

6. Forward Calculations

Forward exchange rates are generally quoted in terms of points or pips. A spot rate is the rate that is in effect today. A forward rate is a fixed exchange rate that we lock in today based on which currencies will be exchanged at some future date.

The table below lists the spot rate and several forward rates for $\rm \frac{USD}{EUR}$ currency pair. The negative sign indicates that the forward rate is less than the spot rate, i.e. the base currency EUR is weakening relative to the US dollar.

Maturity	Spot rate or forward points
Spot	1.2875
One week	– 0.3
One month	– 1.1
Three months	– 5.5
Six months	– 13.3
Twelve months	– 26.5

To convert forward points into a forward rate, divide the points by 10,000 if the exchange rate uses a four decimal place convention and by 100 if the exchange rate uses a two decimal place convention, and then add to the spot rate.

What is the 12-month forward rate?

Forward rate = 1.2875 + – $\frac{26.5}{10,000}$ = 1.28485

At times, forward points can also be expressed as a percentage of the spot rate. For example,

– $\frac{0.00265}{1.2875}$ * 100 = -0.21%

Relationship between Spot Rates, Forward Rates, and Interest Rates

The forward exchange rate depends on relative interest rates. To derive the relationship between spot rates, forward rates, and interest rates, assume you have one unit of domestic currency to be invested for let us say, one year. There are two options you may consider:

The exchange rate convention used = $\rm \frac{Foreign Currency}{Domestic Currency}$ = $\rm \frac{Price Currency}{Base Currency}$

Option 1: Invest one unit of domestic currency (base currency) at the domestic risk-free rate i_B for one period.

Amount at the end of the period = 1 + i_B

Option 2: Convert one unit of domestic currency into foreign currency (base currency) today using the spot rate $\rm \frac{S_p}{B}$ . Invest this amount at the foreign risk-free rate for one period. Determine the forward rate F_P/B today at which the price currency will be converted back to base currency.

Amount of units of price currency at the end of the period = $\rm \frac{S_P}{B}(1 + i_P)$

Amount in terms of base (domestic currency) at the end of the period = $\rm \frac{S_P}{B}(1 + i_P) * \frac{1}{F_\frac{P}{B}}$

Note: By using forward rate, any foreign exchange risk was eliminated in this transaction.

Since the risk of these two investments is the same, they should generate equivalent returns. As an investor, you should be indifferent between the two as it is a no-arbitrage relationship.

$\rm 1 + i_B = \frac{S_P}{B}(1 + i_P) * \frac{1}{F_\frac{P}{B}}$

The above equation can be rewritten as:

$\rm F_\frac{P}{B} = S_\frac{P}{B} * \frac{1 + i_P}{1 + i_B}$

where,

$\rm F_\frac{P}{B}$ = forward rate

i_P = risk – free rate of price currency

i_B = risk – free rate of base currency

Let us use some values now to compute the forward rate. The spot rate for INR/USD $\rm S_\frac{INR}{USD}$ = 100.

The risk-free rate for INR is 10% and the risk-free rate for dollar (base currency) is 1%.

Forward rate $\rm F_\frac{INR}{USD}$ = $\rm S_\frac{INR}{USD} * \frac{1 + i_INR}{1 + i_USD} = 100 * \frac{1 +0.1}{1 +0.01}$ = 108.9108

Some important points to be noted:

The currency with the higher (lower) interest rate will always trade at a discount (premium) in the forward market.
In our example above, USD was the base currency with a risk-free rate of 1%, while INR was the price currency with a risk-free rate of 10%. The forward rate calculated was 108.91 which means that the currency with the lower interest rate (USD) appreciated, while the currency with the higher interest rate (INR) depreciated. (Trading at a discount means the currency depreciates. Trading at a premium means the currency appreciates.)
This relationship ensures that there is no arbitrage. The only forward rate that prevents arbitrage is 108.91. Otherwise, for any rate greater/lesser than 108.91 traders can exploit the mispricing by buying low and selling high.
If the forward contract is for x days, make an adjustment based on the x/360 convention unless told otherwise. Refer to the equation below.
$\rm F_\frac{P}{B} = S_\frac{P}{B} * \frac{1 + (i_P * x/360)}{1 + (i_B * \frac{x}{360})}$