CFA Practice Question

There are 227 practice questions for this study session.

CFA Practice Question

Suppose the domestic currency is the U.S. dollar and the foreign currency is the Canadian dollar.

  • The spot exchange rate is $0.7321.
  • The U.S. interest rate is 3.5%.
  • The Canadian interest rate is 4.25%.
  • Assume these interest rates are fixed and don't change over the life of the forward contract. They are based on annual compounding and are not quoted as LIBOR-type rates.
  • Assume a currency forward contract has a maturity of 90 days.

What should be the forward price if you want to enter into a forward contract to long Canadian dollars in 90 days? What if interest is continuously compounded?
Correct Answer: 0.7308

With discrete compounding:
F(0, T) = F(0, 90/365) = [0.7321/(1.0425)90/365] (1.035)90/365 = 0.7308

With continuously compounding:
r = ln(1.035) = 3.44%, and r(f) = ln(1.0425) = 4.16%
F(0, T) = (0.7321 e -0.0416 (90/365)) e 0.0344 (90/365) = 0.7308

Note that the two rates are equal.

User Contributed Comments 4

User Comment
danlan2 They are always equal.
NIKKIZ Are they not equal just because of rounding? working to 5 decimals I got 0.73076 for discrete compounding and 0.73080 for continuous. Shouldn't continuous compounding increase the value compared to discrete?
tushi123 @nikkiz- since the denominator is larger,continuous compounding will decrease the value
mtsimone No, they're not always equal. The reason they are here is that we're at 4 decimal places (currency future convention) and it's only a 90 day contract. If the contract was 2 years you'd see a difference at 4 decimal places, in fact the difference at 4 places is .0004 and at 5 is .000404. If it were a 500M contract that's 201K+ difference and if it were my portfolio I'll take it.
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