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Calculating the Forward Exchange Rate
1. Determine the spot price of the two currencies to be exchanged. Make sure the base currency is the denominator, and equal to one, when determining the spot price. The numerator will be the foreign currency equivalent to one unit of the base currency. The spot price can be found on any online financial website, or in a newspaper’s financial section.
2. Find the interest rate in the country where the base currency is used. The interest rate is used to account for the time value of money and inflationary expectations in the base country. The interest rate can be found on the website of the national reserve bank; this is true about the foreign interest rate also. Newspapers will show interest rates of major currencies in the financial section.
3. Find the interest rate in the country where the foreign currency is used. This accounts for the time value of money and inflationary expectations in the foreign country.
4. Plug the numbers into the forward exchange rate equation:Forward Exchange Rate= (Spot Price)*((1+foreign interest rate)/(1+base interest rate))^n
5. Use the following as an example. Bro-Land has a spot price of 1 BLD to the equivalent value in Hipsterville of 3HVD. This means the spot price will be 3; 3HVD=1BLD.The interest rate in Bro-Land is 5 percent. The interest rate in Hipsterville is 10 percent. The payment will be made in one year, so n=1.Calculate the forward exchange rate using the equation:Forward Exchange Rate= 3 ( 1.1/1.05)^1= 3.14 HVD = 1 BLD. In one year, 3.14 HVD will be the equivalent of 1 BLD.