If the spot rate for the Swiss Franc (SF) is that 1.15 SF is equal to 1 $U.S., a

Question

If the spot rate for the Swiss Franc (SF) is that 1.15 SF is equal to 1 $U.S., and the annual interest rate on fixed rate one-year deposits of SF is 1.5% and for $U.S. is 2.5%, what is nine-month forward rate for one dollar in terms of SFs? Assuming the same interest rates, what is the 18-month forward rate for one SF in U.S. dollars? Is this an indirect or a direct rate? If the forward rate is an accurate predictor of exchange rates, in this case will the SF get stronger or weaker against the dollar? What does this indicate about the market’s inflation expectations for Switzerland as compared to the United States?

Explanation / Answer

Spot rate

1US$ = 1.15 SF

Annual interest rates for SF = 1.5%, for 9 months = (1.5 / 12) *9 = 1.125%

The nine-month forward rate for one dollar in terms of SFs = 1.15 + 1.125% = $1.1629375

Assuming the same interest rates, 18-month forward rate for one SF in U.S. dollars is calculated as follows:

1US $ = 1.15 SF

so, 1SF = 1/1.15 $US => 1SF = $0.86957

The annual interst rate for $ = 2.5%, for 18 months = (2.5 / 12)*18 = 3.75%

So, the forward rate for 1SF = 0.86957 + 3.57% = $0.90

This is a direct rate for SF.

The SF will get stronger against the dollar as more dollar would be paid for getting 1SF

The inflation rate in switzerland will rise more in comparison to the inflation in US

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