EECS 3101 Lecture Notes - Lecture 27: Singapore Dollar, Spot Contract
28 Jun 2018
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EECS 3101 Lecture 27 Notes
Introduction
Premium or Discount on the Forward Rate
However, if the bank accommodates a five-year forward purchase request on Singapore
dollars, it may be less capable of finding an MNC that wants to sell the same amount of
Singapore dollars five years forward.
Hence the bank may quote a higher bid/ ask spread for a five-year than for a one-year
forward contract, as the five-year contract leaves the bank more exposed to the risk of
appreciation in the Singapore dollar.
The spread between the bid and ask prices is wider for forward rates of currencies of
developing countries, such as Chile, Mexico, South Korea, Taiwan, and Thailand.
Because these markets have relatively few orders for forward contracts, banks are less
able to match up willing buyers and sellers.
The resulting lack of liquidity causes banks to widen the bid/ask spread when quoting
forward contracts.
The contracts in these countries are generally available only for short-term horizons.
The difference between the forward rate (F) and the spot rate (S) at any given time is
measured by the premium: F ¼ Sð1 þ pÞ
Here p denotes the forward premium, or the percentage by which the forward rate
exceeds the spot rate.
EXAMPLE
If the euro’s spot rate is $1.40 and if its one-year forward rate has a forward premium of
2 percent, then the one-year forward rate is calculated
F ¼ Sð1 þ pÞ ¼ $1.40ð1 þ .02Þ ¼ $1.428
Given quotations for the spot rate and the forward rate at any point in time, the
premium can be determined by rearranging the previous equation
F ¼ Sð1 þ pÞ F =S ¼ 1 þ p ðF =SÞ 1 ¼ p
EXAMPLE
