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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




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