I can never really figure out which is which. Is there any rule or trick to remember? I find this especially tricky in this example here:
Consider a forward contract on 1 million Mexican Pesos at $0.08254/MXN. 60 days prior to expiration the U.S. risk-free rate is 5%, the Mexican risk-free rate is 6%, and the spot rate is $0.08211/MXN. The value of the contract to the long is closest to:
Correct answer: -533 USD
The formula:
Vt = St / (1 + Rfor)(T − t) − FT / (1 + Rdom)(T − t)
In this formula, the quotes are (dc/fc); given your numbers, dc = USD, fc = MXN.
Thanks! So, is there a general rule? How do you know its dc/fc in this particular formula? Did you just learn it for every formula?
My pleasure.
None of which I’m aware.
I have more than a passing familiarity with formulae in general, that one in particular.
Nope. I usually think them through.
The rule is your base currency is the one below in the formula.
What is the base currency? It’s the one where it is represented “1 unit of”.
In your example, 1 unit of MXN buys X amount of dollars. So MXN is the base.
FX dealing is a major part of my job ;).
Cool.
So, this stuff’s cake for you.
More like half-baked cake. The way the curriculum is taught on FX quotation is inconsistent with how the global market does it. Therefore, unfortunately, I have to ‘reverse’ whatever inputs CFA gives during the exam to how it is universally understood (otherwise I’d have to learn that up-bid-multiply thingy and triangular arbritage). Much easier that way, since calculation of crosses and arbritrage are already of second nature to me from memory.
I noticed you are a CFA charterholder, so feel free to read this to get a gist of what I am saying. Those taking the exam, DON’T READ IT. This is only going to confuse you now.
http://www.investopedia.com/university/forexmarket/forex2.asp
I hate the way that the market quotes exchange rates. And not merely because it differs from the way CFA Institute does it.