Hi all,
Looking at Book 4 Schweser, pages 92-95 has me confused…
Both caclulaions (answer 2.a & answer 2.b) use a variation of the IRP forumla to arrive at the value of the formula. But in the second forumla, you have to take a second step and PV the difference to arrive at the final answer, while in the first answer no final PVing step is required.
Any tips on why this is?
do it with one way… the way shown on Pg 95
My intuition (way to remember this)
F = S * (1+rd)^T/ (1+Rf)^T
where S and F are in DC/FC
Now to find Value of the Forward (This is just a simple manipulation of the above formula… if you look at it).
St/(!+Rf) ^ (T-t) - F/(1+rd)^(T-t)
think of it in terms of a currency swap.
You (Spot) pay the domestic Notional Principal, Receive foreign Notional Principal.
You would pay the foreign interest rate (so the spot needs to be discounted at the foreign rate).
Similarly Foreign pays Domestic rate - so discount at the domestic rate.
Yeah, the way I think about it is that the value to the long is the current no arb foward price (So*((1+d)^t/(1+f)^t)) minus the foward price he locked into, with that difference PV’d back to present.
FX problems always get confusing for me…
there is no multiple pving back to the initial point if you do it my way.
St (new spot rate) / (1+rf)^t - F (Original Forward Price) / (1+rd)^t is it.
and t = 2 months. e.g. if Original Time Period (say 3 months to start with) and now you are evaluating it at 1 month into contract and St = Spot Rate at 1 month into the contract.