# AID17591: Mr. Mehta was working in the foreign exchange market and was

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SKU: 324e496e96c6 Category:

AID17591: Mr. Mehta was working in the foreign exchange market and was
into calculation of forward premiums/ discount of currencies and also
calculation of expected inflation rates in order to predict the movement of
currency value. He wanted to teach the methodology of calculation to his
subordinate using an example given below:

a. If one year interest rate in UK and Japan are 1.034% and 0.256%
respectively; the spot exchange rate is 172.70 JPY/GBP. What is the forward

b. If the expected inflation rate in UK is 0.07%, what is the expected
inflation rate in Japan?

a)
Forward / Spot = (1 + iA) / (1 + iB)

Forward / 172.70 = 1.00256 / 1.01034

Forward Rate = 172.70 * 0.9923

Forward Rate = 171.37

Base Currency i.e. GBP is at a discount

Annualized forward discount on GBP = [ (F-S) / S ] * 100

= [ (171.37 – 172.70) / 172.70 ] * 100

= -0.77%

JPY is at a forward premium

Annualized forward premium on JPY = [ (S-F) / F ] * 100

= [(172.70 – 171.37) / 171.37] * 100

= 0.78%

b) As per International fisher effect (IFE)

Nominal Interest Rate in UK – Nominal Interest Rate in Japan =
Inflation Rate in UK – Inflation Rate in Japan

(i.e. real rate of interest in UK and Japan would be same, Real
rate = Nominal rate – Inflation Rate)

1.034% – 0.256% = 0.07% – Inflation Rate in Japan

Inflation Rate in Japan =0.07% – 0.778% = -0.708%  AID17591: Mr. Mehta was working in the foreign exchange market and was
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