FX Spot Rates, Forward Rates, and Interest Rates
Consider the following information about the South Korean won (KRW) and the South African rand (ZAR).
| | |
|-----|-----|
| Spot Exchange Rate (ZAR/KRW) | 95.44 |
| South Korean Interest Rate | 7.2% |
| South African Interest Rate | 4.7% |
The forward exchange rate (ZAR/KRW) is:
Incorrect.
The ZAR interest rate should be in the numerator not the denominator
Correct.
To correctly calculate the forward exchange rate, you must multiply the spot exchange rate by the ratio of 1 plus the foreign interest rate to 1 plus the domestic interest rate. The correct formula is given below, indicating the depreciation of the KRW against the ZAR.
$$\displaystyle F_{f/d} = S_{f/d} \left( \frac{1 + r_f}{1 + r_d} \right) $$
$$\displaystyle \mbox{Forward exchange rate} = 95.44 \times \frac{1.047}{1.072} = 93.21 \mbox{ ZAR/KRW} $$
Incorrect.
This answer could be the result of adding 1 to each of the interest rates (in whole numbers) before calculating their ratios and then switching the numerator and denominator.
66.34 ZAR/KRW.
93.21 ZAR/KRW.
97.72 ZAR/KRW.
