Question

The spot and 1-month forward rates for the British Pound are \$1.5800/f and $1.5520/£, respectively. If the dollaris the home currency, the British Pound is said to be selling at a forward

Answer 1

Solution:

The formula for calculating the annualized forward premium / discount on a given currency is

= [ ( Forward rate – Spot rate ) / Spot rate ] * ( 12 / No. of months ) * 100

As per the information given in the question we have

Forward rate of British Pound = $ 1.5520      ;   Spot rate of British Pound = $ 1.5800   ;

No. of months = 1

Applying the above values in the formula we have

= [ ( 1.5520 – 1.5800 ) / 1.5800 ] * ( 12 / 1 ) * 100

= [ - 0.0280 / 1.5800 ] * 12 * 100

= - 0.017722 * 12 * 100

= - 0.212658 * 100

= - 21.2658 %   

= - 21.27 % ( when rounded off to two decimal places )

Since the solution is negative the British pound is said to be selling at a forward discount.