Question

When using forward contracts, is the current spot rate between the two currencies relevant? Is the future, actual spot rate (when the forward contract matures) between the two currencies relevant?

Answer 1

Forward contracts are non standardized contracts ,traded over the counter, between two parties to exchange currencies at a pre determined rate and at a predetermined maturity date.

The predetermined rate (called as forward spot rate FSR) is calculated using current spot rate (CSP)and interest rates of the currencies involved.

FSR = CSP × [(1+foreign interest rate)/(1+domestic interest rate)]

So, the current rate is absolutely relevant for forward contracts.

Future(FSP) and actual spot rate ( when forward contract matures FASP) are both relevant. It helps investor to calculate his losses or gains.

For eg. Consider.

FSP = £80/$

FASP= £79/$

An investor , who has to buy dollars, will pay £80 as per the contract. But if hadn't entered into the contract, he would've spent £79 to buy one dollar from open market.  So, he earned a loss of £1/$.

Therefore, as explained all the rates whether CSP, FSP. FASP are relevant to forward contracts involving currencies.

Hope it helps. Thankyou.