1. What is the Forward Exchange Rate Formula?

Definition: This formula calculates the forward exchange rate based on the spot rate, domestic and foreign interest rates, and time period.

Purpose: It helps investors and financial professionals determine the future exchange rate between two currencies based on interest rate differentials.

2. How Does the Formula Work?

The formula is:

Where:

• \( F \) — Forward exchange rate
• \( S \) — Current spot exchange rate
• \( r_d \) — Domestic interest rate (in decimal form)
• \( r_f \) — Foreign interest rate (in decimal form)
• \( t \) — Time in years

Explanation: The formula accounts for interest rate parity, where the forward rate reflects the interest rate differential between two currencies.

3. Importance of Forward Exchange Rate

Details: Forward rates are crucial for hedging currency risk, pricing forward contracts, and making international investment decisions.

4. Using the Calculator

Tips: Enter the current spot rate, domestic and foreign interest rates (as decimals), and time period in years. Spot rate and time must be > 0.

5. Frequently Asked Questions (FAQ)

Q1: Why do we need forward exchange rates?
A: They allow businesses and investors to lock in exchange rates for future transactions, reducing currency risk.

Q2: How do I convert percentage rates to decimals?
A: Divide the percentage by 100 (e.g., 5% becomes 0.05).

Q3: What happens if domestic rates are higher than foreign rates?
A: The forward rate will typically be lower than the spot rate (the currency trades at a forward discount).

Q4: Can this formula be used for any time period?
A: Yes, but ensure all rates are annualized and time is expressed in years (e.g., 3 months = 0.25 years).

Q5: What assumptions does this formula make?
A: It assumes no arbitrage opportunities, no transaction costs, and that interest rates remain constant.