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Sem 5 Prep
← Open Economy MacroSpot, forward, swaps, futures and options

Formulas for this chapter

Forward discount or premium, annualised

FD or FP = ((FR - SR) / SR) x (12 / n) x 100

Any question giving a spot rate and a forward rate. Positive is a premium, negative a discount. The slide's 'x 4' is only the n = 3 case.

FR
Forward rate, in domestic currency per unit of foreign currency
SR
Spot rate, the same way round, and always the denominator
n
Maturity in months: factor is 12 for one month, 4 for three, 2 for six, 1 for twelve

Cost of forward cover

Cost of cover = amount x (FR - SR) as a % of the spot value = (FR - SR) / SR x 100

Comparing a forward contract with paying at today's spot rate. A premium makes cover a cost; a discount makes it a saving.

Amount
The foreign currency sum being covered
FR - SR
Positive means the hedger pays for certainty; negative means the hedger is paid for it

Swap rate

Swap rate = forward rate - spot rate

Pricing a currency swap, which is a spot sale plus a forward repurchase in one transaction. It is the same raw gap that the annualised premium or discount is built from.

Forward rate
The rate on the repurchase leg
Spot rate
The rate on the sale leg, settling within two business days
Step 1 of 25
The ideaTheory

Buy it now, or promise to buy it later

Two ways to get mangoes in June. Walk to the market in June and pay whatever they cost. Or agree in February with a farmer on a price for June delivery.

The first is a spot deal. The second is a forward contract. Every instrument in this chapter is one of those two with a variation.

The variation matters because you will be examined on the differences: whether the contract is standardised, whether you are obliged to go through with it, and whether it can be resold before it matures.

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