Exercise Set 4.1
FORWARD PREMIUMS AND DISCOUNTS

I. Objectives

1. To understand spot exchange rates and forward exchange rates
2. To compute the forward premium at which a foreign currency is trading

II. Data

Consider the dollar/pound exchange rate (E_$/pound).

• Select values for the spot rate, S, and the 3-month forward rate, F.

• Compute the annualized forward premium/discount for the pound.

III. Questions

1. Obtain the spot rate and the 3-month forward rate for the pound from The Wall Street Journal.

2. Is the pound expected to depreciate, or appreciate, relative to the dollar over the next 90 days? Explain.

3. Compute the annualized premium (or discount) for the forward pound.

4. Suppose the spot rate rises by 10%. [This implies that the spot pound has strengthened.] Assuming the forward rate stays the same, compute the new annualized premium.