Forward Rates
In addition to spot transactions, currencies can also be bought and sold today for delivery at some future tune, usually - 50, 90, or 180 days from today. In these cases, Forward rates are used, rather than spot rates. Forward exchange rates between U.S. dollars and the currencies of several of the major industrial countries also are reported daily in the Wall Street Journal. Table 3-3 lists some forward exchange rates as of December 1, 19Q3.
A comparison of the spot and forward rates in Tables 3-2 and 3-3 shows that the 30, 90 and 180-day forward rates for the British pound, Canadian dollar,
Table 3 — 3. Forward Foreign Exchange Rates
Source: Wall Street Journal (December 2, 1993)
|
|
EXCHANGE RATE (U.S. DOLLARS) DECEMBER 1, 1993 | ||
|
Currency |
30-Day Forward |
90 Day Forward |
180-Day Forward |
|
Pound |
$1.4751 |
$1.4707 |
$1.4650 |
|
Canadian dollar |
0.7492 |
0.7488 |
0.7473 |
|
French franc |
0.16778 |
0.16696 |
0.16602 |
|
Yen |
0.009201 |
0.009212 |
0.009263 |
|
Swiss franc |
0.6650 |
0.6641 |
0.6637 |
|
Mark |
0.5791 |
0.5767 |
0.5740 |
French franc, Swiss franc and the German mark are below their respective spot rates, indicating a market expectation that these currencies will lose value relative to the dollar over this time horizon. In contrast, the forward rates for the Japanese yen are above the spot rate ($0.009191/yen), indicating an expectation of increasing value of the yen relative to the dollar.
The premium or discount between the spot rate, S0, and a forward rate, F, for a currency (relative to the dollar, for example) can be expressed on an annualized percentage basis (using direct quotes) as follows:
(3.1)
where n is the number of months in the forward contract. A positive value calculated using Equation 3.1 indicates that a currency is trading at a forward premium relative to the dollar, whereas a negative value indicates a forward discount.
Using the exchange rates from tables 3-2 and 3-3 the following annualized discount for the 180-day forward quote on the Deutsch mark (DM) can be calculated:
Similarly, the annualized premium for the 180-day forward quote on the Japanese yen can be calculated as:
Thus we can say that the DM is trading at a forward discount relative to the dollar (i.e., the dollar is expected to strengthen relative to the DM), and the yen is trading at a forward premium relative to the dollar (i.e., the dollar is expected to weaken relative to the yen).
As shown later in the chapter, firms engaged in international transactions can use the forward foreign exchange market to hedge against the risk of adverse fluctuations in exchange rates.