Skip to content

ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

Spot is 1.6000 and the 1-year forward rate is 1.6320 (foreign currency per home currency unit). A home-currency exporter hedges a 1-year foreign receipt. Under interest rate parity, which relationship between 1-year interest rates is implied?

Foreign interest rates are about 2% higher than home rates. The forward rate divided by spot is 1.02, and under interest rate parity that ratio equals one plus the foreign rate over one plus the home rate. The foreign currency therefore trades at a forward discount reflecting the interest differential.

  1. AForeign interest rate is 2% higher than home rate, approximately, as forward foreign units per home unit riseCorrect
  2. BForeign interest rate is 2% lower than home rate, approximately
  3. CInterest rates are equal
  4. DHome currency is expected to appreciate by 2% because the forward is higher

Explanation

Forward/spot = 1.0200. Under IRP, F/S = (1+i foreign)/(1+i home), so foreign rates exceed home by about 2%. The foreign currency trades at a forward discount (more units per home unit), consistent with higher foreign interest rates. Option D misreads the forward rate as an appreciation of home currency expectation rather than an interest differential.

Did you get it right without looking?

One question tells you little. A timed set on The use of financial derivatives to hedge against forex risk shows your real accuracy, how long you take and where you lose marks.

Practise The use of financial derivatives to hedge against forex riskFree diagnostic mock

More The use of financial derivatives to hedge against forex risk questions