*****Solve Number 2********* number 1 is already done!!!! 1. If the spot rate fo

Question

*****Solve Number 2********* number 1 is already done!!!!

1. 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?  

Spot Rate

1 USD = 1.15 SF

SF interest Rate = 0.25%

USD interest Rate = 1.75%

Forward Rate = Spot Rate x (1 + Interest Rate of Overseas Country)

                                                 (1+ Interest Rate of Domestic Country)

What is 9-month forward rate for one dollar in terms of SFs?

9-month forward rate for 1 USD

            1 USD = 1.15 * (1 + (0.25% * (9/12)))

                                       (1 + (1.75% * (18/12)))

1 USD = 1.13723 SF

What is the 18-month forward rate for one SF in US$s?

18-month forward rate for 1 USD

            1 USD = 1.15 * (1 + (0.25% * (18/12)))

                                       (1 + (1.75% * (18/12)))

            1 USD = 1.12479 SF

Is this an indirect or a direct rate?

In US, this is an indirect rate, and lower exchange rate, and lower exchange rate implies that the domestic currency is depreciating; it is worth a smaller amount of foreign currency.

If the forward rate is an accurate predictor of exchange rates, in this case will the SF get stronger or weaker against the dollar?

Forward rates are exchange rate adjusted for interest rate differentials, so not good predictors of future spot rate. In this case, SF is expected to get stronger against the US dollar.

What does this indicate about the market’s inflation expectations for Switzerland as compared to the US?

This indicates the market’s inflation expectations for Switzerland will be lower as compared to the US.

2. On June 1st, 2016, Swatch expects to ship 3,500,000 watches from its Swiss plant to the US that it will sell through retail outlets on 270-day terms at $65 each. Therefore Swatch will receive payment from these outlets on February 25th, 2017. Assuming that Swatch needs to cover its expenses in Switzerland and thus wants to hedge its SF/US$ exposure using a forward contract with a Swiss bank, what is the minimum amount of Swiss Francs they should receive on February 25th, 2017 given the 9-month forward rate you calculated in problem one for one US dollar in terms of Swiss Francs? What are two other ways Swatch might hedge its SF/US$ exposure? Show calculations!!!

Explanation / Answer

As solved in part 1, nine-monh forward rate for 1 USD = 1.13723 SF .

Swatch expects to sell 3.5 million watches on nine-month terms, so they should expect to receive 65 x 1.13723 = 72.92 SF for a watch.

That means 258,719,849 SF for 3.5 million watches.

The other ways of currency hedging are -

1- Buy currency ETFs

2. Buy currency of a country that has high interest rates.

3. Buy an undervalued currency.

4. Short-Sell overvalued currency

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