In the econ section it seams like when calculting future expected exchange rates that the DOMESTIC Inflation or Risk Free rate are the denomonator and the Foriegn is the numerator (Eg. S1 = So (1+iFC)/(1+iDC)…F=S(1+rFC)/(1+rDC).
Now under Portfolio Management for expected rate is given by F = S(1+rDC)/(1+rFC).
I think theres something maybe I’m not understanding as to why its different. Can anyone help? Getting confused on this and can’t seem to make sense of it now.
Don’t go by the DF/FC convention. They are saying the same thing but differently as S and F will be stated differently. Try the same numerator/denominator as you have in the spot rate and forward rate. For example, if your spot rate and forward rates are in USD/GBP, use r(USD)/r(GBP).
ahhhh, I see. So they are just quoting the rates differently in the two sections? I think I remember seeing a warning about that somewhere. A bit tricky.
Actually it’s easy once you figure it out. Make sure its in reverse when you calculate the real exchange rate and that is the only place where that happens.
DC/FC only confuses an otherwise easy concept. Ignore it completely.
just rem if u r given with a direct quote(one unit of DC for x units of FC) DC will be on top in the formula
Yes - try and think of everything in the direct quote / indirect quote convention.
Direct quotes are meant to give you an idea of the price of the FOREIGN currency. Ie, 1 Euro will cost me 2 dollars (direct quote to an American investor).
If the forward rate is, say, 3 (ie, 1 Euro will cost me $3 - also known as “forward rate EUR:USD = 3”) then the Euro is trading at a forward premium because it costs more dollars to buy a Euro.
And as harry said - if you’re given a quote in this convention, the domestic currency rate should be on top in the formula.
Ignore this American investor, British investor…FC, DC nonesense. It will only complicate things for you.
Clearly it already seems complicated, but ignoring people trying to do their best to explain it in an understandable way is not a value add either.