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Derive a forecast of the spot rate in 2 years using todays 2 year forward rate

 
Derive a forecast of the spot rate in 2 years using today’s 2-year forward rate.
 
1: Compute the forward premium/discount assuming IRP exists.
 
Required inputs:
- Annualized interest rate on a risk-less Thai security : 1.660%
- Annualized interest rate on a risk-less United Kingdom security: 0.109%
 
2: Use the relationship between the forward rate, spot rate and forward premium to determine the 2-year forward rate. i.e. F=S(1+p)
 
P = [(1+iH)]^year/(1+iF)^year] - 1
P = [(1+0.01660)^2/(1+0.00109)^2] - 1
P = (1.0335/1.0021) - 1
P = 1.0313 - 1 = 0.0313
Forward premium on GBP = 3.13% premium
 
Spot exchange rate:
1 GBP = 43.67 THB
P = 0.0313
F = S(1+p)
F = 43.67(1+0.0313)
F = 45.036
 
Forward exchange rate:
1 GBP = 45.036 THB; 3.13% appreciate.
 
3: The forward rate is your forecast of the spot rate in 2 years.
Answer the following question:
Why can the forward rate be used as a forecast of the future spot rate? Explain.

May 25 2018 View more View Less

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