Get finance assignment help on the forecast for the British pounds one year forward One Year Forward Rate Calculation Forward Rate of British Pound based on Interest Rate Parity (IRP): One year Forward Exchange Rate= (Spot Price)*((1+foreign interest rate)/(1+Home interest rate))^n (Madura, 2012) Spot price = 1.6200 Foreign interest rate = 0.78% Home interest rate = 1.58% Number of years = 1 =1.6200*((1+0.78%)/(1+1.58%))^1 = 1.6200*(1.0078/1.0158)^1 = 1.6200*0.992 =1.60704 $/P

 

Forward Rate of British Pound based on Purchasing Power Parity (PPP): The PPP is hold, so following formula will be used to calculate the one year forward rate: e_t = [e₀*{(1+i_h)^t/(1+i_f)^t}] (Madura, 2012) Where, e_t= one year forward rate e₀ = Spot rate = 1.6200 i_h = Home inflation rate = 4.2% i_f = Foreign inflation rate = 3% = 1.6200*((1+3%)/(1+4.2%))^1 = 1.6200*(1.03/1.042) = 1.6200*0.988 = 1.60056 $/P

 

Forecasting with Forward Rates: The magnitude of percentage appreciation or depreciation is measured as follows: % appreciation/depreciation base currency= (New rate-old rate)/ old rate (Melicher & Norton, 2010) The forward rate premium (or discount) of the British pound on the basis of IRP would be: The British pounds spot rate is 1.6200 $/P and the one year sport rate (on IRP) is 1.60704 $/P then the British pounds rate change is: = (1.60704-1.6200) / 1.6200 = -0.008 or -0.8% The negative value indicates the depreciated value of the British pound. The sport rate of the British pound on the basis of IRP is expected to depreciate by 0.81% over the next one year period. The forward rate premium (or discount) of the British pound on the basis of PPP would be: The British pounds spot rate is 1.6200 $/P and the one year sport rate is 1.60056 $/P then the change in British pound is: = (1.60056-1.6200) / 1.6200 = -0.012 or -1.2%

 

So, the sport rate of the British pound on the basis of PPP is expected to depreciate by 1.2% over the next one year period. We also can do finance case study assignment help.

 

Comment on Forward Rate: The one-year forward rate is unbiased estimation of future spot rate in one year. It is because in UK inflation rate is high along with high interest rate in compare to inflation and interest rate in USA. It shows that the future financing rate in US will be similar as the domestic financing rate as higher inflation rate will cause currency devaluation. If the interest rate parity exists then firm in UK will be able to achieve the lower financing cost by borrowing the foreign currency constantly. According to IPR, the forward rate is unbiased as UK has higher interest rate and higher inflation rate, which may cause a decline in its currency value over the time in compare to US currency. Similarly, under PPP also the future spot rate is declining because of the higher inflation rate in UK then USA.

 

Compare, Contrast and Explain the IRP & PPP: The IRP determines the relationship between interest rate between the two countries and the forward premium, while PPP indicates a relationship between the inflation differential of two countries and the percentage change in the spot rate over the time. One year forward exchange rate of British pond is approximately similar in IRP and PPP that represents that investors would earn similar yield over the period. Calculation of IRP and PPP suggests that the British pound will be depreciated over the time. It represents those foreign investors, who will purchase British pound, would receive an average yield similar to USA rates. But at the same time, both estimations have different bases for the determination of one-year forward rate as IRP considers interest rate, while PPP considers inflation rate in both economies over the period.

 

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