If the spot rate for the Swiss Franc is that 1.15 SF is equal to 1 US $, and the

Question

If the spot rate for the Swiss Franc is that 1.15 SF is equal to 1 US $, and the annual interest rate on fixed rate one-year deposits of SF is 0.25% and for US$ is 1.75%, 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 US$s? 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 US?

Explanation / Answer

Using interest rate parity theory, forward rates are calculated as follows:

                SF Interest rate for 9 months = (1.75% / 12) * 9 = 0.1875%

                U.S Interest rate for 9 months = (0.25% / 12) * 9 = 1.3125%

Forward 1 U.S $ (1 + 1.3125%) = 1.15 SF (1 + 0.1875%)

                Forward 1 U.S $ = 1.1522 SF / 1.0131

                Forward 1 U.S $ = 1.1373 SF

Using interest rate parity theory, forward rates are calculated as follows:

                SF Interest rate for 18 months = (1.75% / 12) * 18 = 0.375%

                U.S Interest rate for 18 months = (0.25% / 12) * 18 = 2.625%

Forward 1 U.S $ (1 + 2.625%) = 1.15 SF (1 + 0.375%)

                Forward 1 U.S $ = 1.1543 SF / 1.02625

                Forward 1 U.S $ = 1.1248 SF

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