FOREIGN EXCHANGE FORWARD

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A Foreign Exchange Forward ("FX Forward") is a contract to set today an exchange rate that will apply to a certain notional principal at a specified future period of time. An FX Forward is generally settled in cash at contract maturity.

The pricing of an FX Forward is equivalent to determining the forward foreign exchange rate. Since the expected net present value of an at-market forward contract must be zero at origination, the easiest way to obtain the forward exchange rate is to determine the exchange rate that guarantees that the net present value of the contract is zero. This relation is called interest rate parity; the technique used to do this is called covered-interest arbitrage.

The forward foreign exchange rate at contract origination, Ft , can be calculated with the following general formula:

Ft = S0 * [(1 + R2) / (1 + R1)]

where

Ft = forward foreign exchange rate at time period T (expressed as unit of foreign currency per unit of domestic currency)

S0 = today's spot foreign exchange rate (foreign currency per unit of domestic currency)

R2 = foreign interest rate for time period T

R1 = domestic interest rate for time period T

This calculator uses simple interest and 30/360 daycount convention.

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