Forex Question

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kuragari

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The spot rate for the NZD is 1.4286 NZD/ USD, and the 180-day forward contract rate is 1.3889 NZD/ USD means:

a) Interest rates must be lower in the US than in NZD
b) Interest rates must be highter in the US than in NZD
c) The NZD is expected to deppreciate
d) The USD is expected to appreciate

If someone answer this question and explain why.

Never let them see you coming
 
I am going with a

c&d have the same result... if the NZD is expected to depreciate or if the USD is expected to appreciate the forward rate would be more NZD per USD than the spot rate

so if interest rates were lower in the US... 180 days from now the FV of 1 USD would be less than the FV of 1 NZD and therefore the market would pay fewer NZD's for a USD 180 days from now

of course I have been drinking tonight.
 
It's B. Based upon the covered interest rate parity F = S * (1+rNZD / 1+rUSD). Since F is lower than S we know that rNZD < rUSD. If A were to be true the USD would appreciate, which is clearly contrary to the stated forward rate.

C and D are saying the same thing, if the NZD goes down the USD goes up, but the forward rate is telling us 1 USD will buy less NZD so both C and D are incorrect.
 
ok, james' logic sounds fine but I'll go with 'A'

here's my reasoning..
its clear that NZD appreciates----> more demand for NZD ---> people are selling USD and buying NSD ----> they might be doing this because NZD is a better investment than US ---> NZD can be a better investment because interest rates are higher there.---> A

tell us the answer kuragiri. and if i'm wrong, can someone please point out the logical fallacy in my statement?
 
In fact, I think james' logic is impeccable. It's B. Forward rates don't have anything to do with that stuff that bhaiyyu wrote.

forward rates are just the no arbitrage rates for exchanging into a currency at some known time in the future when an FX buyer can buy (and sell) bonds from either country. So if a US buyer wants 1.3889 M NZD in 180 days he can:
a) Enter into a 180 day forward contract and invest $ 1 M/(1 + r$) in US deposits; or
b) Convert at spot rate to have (1.3889 M )/(1 + rNZD) NZD and invest in NZD risk-free securities.

(r$ and rNZD above are 180-day rates in US and NZ respectively)

Since both of these are equal in 180 days for sure and for certain, they must be equal now. The rest is just the math that James wrote down. There is no issue of supply and demand, better investment, yada, yada. Just covered interest arbitrage.
 
The answer is B.

"Interest rates are higher in the U.S. than in New Zealand. It should take fewer NZD to buy a USD in the forward market as the forward NZD appreciates."

This was the answer given, but I chose A.
My reasoning is that since it takes less NZD to buy 1 USD in the forward rate, that means that the NZD has appreciated. B/c of this, interest rates in the U.S. must be lower than in New Zealand.

I'm still a bit lost w/ this reasoning for B though. If F < S how come rNZD < rUSD?

Never let them see you coming
 
Take it to an extreme. Suppose interest rates in the US were 0 and interest rates in NZ were 90%. If the forward rate was equal to the spot rate, you would take your dollars, convert them at the spot rate, lock in the rate with a forward contract, and deposit your money in NZD making an annualized no-risk 90% return (on notional capital!). This just can't be. So the thing that must be wrong is the forward rate. In this case, the forward will give me fewer dollars after 180 days than I had originally.
 
Good example. I guess using the formula's would be a good thing during the exam, like the one that you used F(1+Rf)=S(1+Rs). That will definitely give me a better picture. Thanks!

Never let them see you coming
 
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