Encyclopedic Dictionary of International Finance and Banking Phần 5 doc

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Arbitrageurs wish to earn risk-free profits; hedgers, importers, and exporters want to protect

the home currency values of various foreign currency-denominated assets and liabilities; and

speculators actively expose themselves to exchange risk to benefit from expected movements

in exchange rates. It differs from the futures market in many significant ways.

See also FUTURES; HEDGE.

FORWARD MARKET

See FORWARD FOREIGN EXCHANGE MARKET.

FORWARD MARKET HEDGE

A forward market hedge is a hedge in which a net asset (liability) position is covered by a

liability (asset) in the forward market.

EXAMPLE 52

XYZ, an American importer, enters into a contract with a British supplier to buy merchandise

for £4,000. The amount is payable on delivery of the goods, 30 days from today. The company

knows the exact amount of its pound liability in 30 days. However, it does not know the payable

in dollars. Assume further that today’s foreign exchange rate is $1.50/£ and the 30-day forward

exchange rate is $1.49. In a forward market hedge, XYZ may take the following steps to cover

its payable.

Step 1. Buy a forward contract today to purchase (buy the pounds forward) £4,000 in 30 days.

Step 2. On the 30th day pay the foreign exchange dealer $5,960.00 (4,000 pounds × $1.49/£)

and collect £4,000. Pay this amount to the British supplier.

By using the forward contract, XYZ knows the exact worth of the future payment in dollars

($5,960.00). The currency risk in pounds is totally eliminated by the net asset position in the

forward pounds.

Note: (1) In the case of the net asset exposure, the steps open to XYZ are the exact opposite:

Sell the pounds forward (buy a forward contract to sell the pounds), and on the future day receive

and deliver the pounds to collect the agreed-upon dollar amount. (2) The use of the forward

market as a hedge against currency risk is simple and direct. That is, it matches the liability or

asset position against an offsetting position in the forward market.

See also MONEY-MARKET HEDGE.

FORWARD PREMIUM OR DISCOUNT

The forward rate is often quoted at a premium to or discount from the existing spot rate. The

forward premium or discount is the difference between spot and forward rates, expressed as

an annual percentage, also called forward-spot differential, forward differential, or exchange

agio. When quotations are on an indirect basis, a formula for the percent-per-annum forward

premium or discount is as follows:

where n = the number of months in the contract.

Forward premium ( ) + or discount ( ) − Spot Forward –

Forward ------------------------------------ 12

n = × ----- × 100

FORWARD MARKET

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EXAMPLE 53

Assume that the spot exchange rate = ¥110/$ and the one-month forward rate = ¥109.66/$. Since

the spot rate is greater than the one-month forward rate (in indirect quotes), the yen is selling

forward at a premium.

The 1-month (30-day) forward premium (discount) is:

The 3-month (90-day) forward premium (discount) is:

[(¥110.19 − ¥108.55)/¥108.55] × 12/3 × 100 = +6.04%

The 6-month (180-day) forward premium (discount) is:

[(¥110.19 − ¥106.83)/ ¥106.83] × 12/6 × 100 = +6.29%

Note: A currency is said to be selling at a premium (discount) if the forward rate expressed in

indirect quotes is less (greater) than the spot rate.

With direct quotes:

Note: A currency is said to be selling at a premium (discount) if the forward rate expressed in

direct quotes is greater (less) than the spot rate.

Exhibit 58 shows forward rate quotations and annualized forward premiums (discounts).

Note: In Exhibit 58, since a dollar would buy fewer yen in the forward than in the spot

market, the forward yen is selling at a premium.

FORWARD RATE

See FORWARD EXCHANGE RATE.

EXHIBIT 58

Forward Rate Quotations and Annualized Forward Premiums (Discounts)

Quotation ¥/$ (Indirect Quote) $/¥ (Direct Quote) % per Annum

Spot Rate ¥110.19 $0.009075

Forward

1-month 109.66 0.009119 +5.80%

3-month 108.55 0.009212 +6.04%

6-month 106.83 0.009361 +6.29%

¥110.19 – ¥109.66

¥109.66 -------------------------------------------- 12

1 × +5.80% ----- × 100 =

Forward premium or discount Forward Spot –

Spot ------------------------------------ 12

1 = × ----- × 100

Forward premium or discount $0.009119 $0.009075 –

$0.009075 -------------------------------------------------------- 12

1 = = × + ----- × 100 5.80%

FORWARD RATE

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FORWARD RATE QUOTATIONS

The quotations for forward rates can be made in two ways. They can be made in terms of

the amount of local currency at which the quoter will buy and sell a unit of foreign currency.

This is called the outright rate and it is used by traders in quoting to customers. The forward

rates can also be quoted in terms of points of discount and premium from spot, called the

swap rate, which is used in interbank quotations. The outright rate is the spot rate adjusted

by the swap rate. To find the outright forward rates when the premiums or discounts on quotes

of forward rates are given in terms of points (swap rate), the points are added to the spot

price if the foreign currency is trading at a forward premium; the points are subtracted from

the spot price if the foreign currency is trading at a forward discount. The resulting number

is the outright forward rate. It is usually well known to traders whether the quotes in points

represent a premium or a discount from the spot rate, and it is not customary to refer

specifically to the quote as a premium or a discount. However, this can be readily determined

in a mechanical fashion. If the first forward quote (the bid or buying figure) is smaller than

the second forward quote (the offer or selling figure), then it is a premium—that is, the swap

rates are added to the spot rate. Conversely, if the first quote is larger than the second, then

it is a discount. (A 5/5 quote would require further specification as to whether it is a premium

or discount.) This procedure assures that the buy price is lower than the sell price, and the

trader profits from the spread between the two prices. For example, when asked for spot, 1-,

3-, and 6-month quotes on the French franc, a trader based in the United States might quote

the following:

.2186/9 2/3 6/5 11/10

In outright terms these quotes would be expressed as indicated as follows:

Notice that the 1-month forward franc is at a premium against the dollar, whereas the 3- and

6-month forwards are at discounts. Note: The literature usually ignores the existence of bid

and ask prices, and, instead, uses only one rate, which can be treated as the midrate between

bid and ask prices.

FORWARD RATES AS UNBIASED PREDICTORS OF FUTURE SPOT RATES

Because of a widespread belief that foreign exchange markets are “efficient,” the forward

currency rate should reflect the expected future spot rate on the date of settlement of the

forward contract. This theory is often called the expectations theory of exchange rates.

EXAMPLE 54

If the 90-day forward rate is DM 1 = $0.456, arbitrage should ensure that the market expects

the spot value of DM in 90 days to be about $0.456.

An “unbiased predictor” intuitively implies that the distribution of possible future actual spot

rates is centered on the forward rate. This, however, does not mean the future spot rate will

actually be equal to what the future rate predicts. It merely means that the forward rate will, on

Maturity Bid Offer

Spot .2186 .2189

1-month .2188 .2192

3-month .2180 .2184

6-month .2175 .2179

FORWARD RATE QUOTATIONS

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