A bank has been asked to provide a three-month forward AUD/USD 'buy' quote for a corporate client.The following information is available to the FX dealer at the bank:
Spot rate:AUD/USD 0.7654-0.7659
US interest rates:7.73% per annum
Australian interest rates:8.64% per annum
Estimate the three-month forward 'buy' rate.
A) 0.7637
B) 0.7639
C) 0.7642
D) 0.7644

Question

Quizplus · Accepted Answer

To estimate the three-month forward 'buy' rate, we use the interest rate parity formula, which accounts for the interest rate differential between the two currencies. The formula for calculating the forward rate is:Forward Rate = Spot Rate x (1 + Interest Rate of Quote Currency) / (1 + Interest Rate of Base Currency)Given that the 'buy' rate for AUD/USD means we are looking at buying AUD and selling USD, the quote currency is USD and the base currency is AUD. The spot rate to use is the 'buy' rate from the bank's perspective, which is 0.7654 (the lower rate in the spot quote).Plugging in the numbers:Forward Rate = 0.7654 x (1 + 0.0773/4) / (1 + 0.0864/4)This calculation takes into account that the interest rates are annual, and we are calculating for a three-month (or one-quarter) period, hence the division by 4.After performing the calculation:Forward Rate ≈ 0.7654 x (1 + 0.019325) / (1 + 0.0216) ≈ 0.7654 x 1.019325 / 1.0216 ≈ 0.7654 x 0.99776 ≈ 0.7637Therefore, the estimated three-month forward 'buy' rate is approximately 0.7637.

A Bank Has Been Asked to Provide a Three-Month Forward