in 2014, textbook Reading 28, question 22

CFA Level III Derivatives
#1

In textbook 292, reading 28, question 22, the third paragraph says “due to recent monetary tightening by the Riksbank forward points for the SEK/EUR rate have swung to a premium.”

I do not understand the relationship. If the monetary policy is tighten, then there is less money supply, which means SEK will appreciate. So the SEK/EUR will decrease in the future (e.g. from 3 SEK per EUR to 2.5 SEK per EUR). Then the forward rate of SEK/EUR will decrease, which means a forward discount. Then why “forward points for the SEK/EUR rate have swung to a premium”?

#2

Hey,

I think because the forward rate will reflect the interest rate parity relationship. Since Riskbank raised rates relative to EUR, EUR should trade at a forward premium.

Hope it helps

#3

The forward rate you seek is EUR/SEK, not SEK/EUR. SEK/EUR will have negative forward points; EUR/SEK will have positive forward points.

#4

S2, where did you get this, it says the SEK/EUR is at a forward premium.

#5

All I’m saying is that if you want to know whether SEK is appreciating or depreciating, look at EUR/SEK, not SEK/EUR. If EUR/SEK increases, SEK is appreciating; if EUR/SEK decreases, SEK is depreciating.

#6

S2000 - I am having trouble understanding the same question. Why would nominal rates for the SEK be expected to increase for tight monetary policy? Wouldn’t tight monetary policy = low expected inflation, and thus lower nominal rates? Confused as to why nominal rates would increase?

#7

Tight monetary policy means raising interest rates.

Inflation will likely decline, but real rates will increase more; the net effect is higher nominal rates.