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CFA Level I · CFA Level I Exam · Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

A currency forward contract is priced using covered interest rate parity. The spot rate is quoted as price currency per unit of base currency. The forward rate will most likely be higher than the spot rate when:

The forward rate exceeds the spot rate when the price-currency interest rate is higher than the base-currency rate. Under covered interest rate parity, F equals S times (1 plus price rate) over (1 plus base rate), so a higher price-currency rate raises the forward.

  1. Athe price-currency interest rate is higher than the base-currency interest rate.Correct
  2. Bthe base-currency interest rate is higher than the price-currency interest rate.
  3. Cthe two interest rates are equal and the spot rate is above its long-run average.

Explanation

Covered interest rate parity gives F = S x (1 + i_price)/(1 + i_base). The forward exceeds spot when the price-currency rate is above the base-currency rate. If rates are equal, F equals S whatever the long-run level of spot.

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