Page 144 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx
P. 144
Chapter 12
Example 4
The current spot exchange rate between sterling and the dollar is USD
1.2525/GBP. The sterling six month interest rate is 1.15% pa and the dollar six
month interest rate is 1.75% pa.
What should the three month USD/GBP forward rate be?
A 1.2488
B 1.2451
C 1.2562
D 1.2599
Solution
Applying interest rate parity:
ih = 1.15% × 6/12 = 0.575%; if = 1.75% × 6/12 = 0.875%
Spot × (1 + if)/(1+ ih) = 1.2525 × 1.00875/1.00575 = 1.2562
or
Invest GBP 1,000 at 1.15% for six months (0.0155/2) = GBP 1,005.75
Convert GBP1,000 to USD at 1.2525 = USD 1,252.5
Invest that at 1.75% for six months (0.0175/2) = USD 1,263.459375
Implied forward rate is therefore 1,263.459375/1,005.75 = 1.2562
Illustrations and further practice
Look at the illustration in Chapter 12 on IRPT and try TYU 5 – 7
134