Details of an Interest Rate Swap ContractAn interest rate swap is an exchange of cash flows between two parties where party A pays a fixed ra...
Lessons
- CFA Level 2: Derivatives Part 1 – Introduction
- What are Forward Contracts?
- Equity Forward Contracts
- Fixed Income Forward Contracts
- Currency Forward Contracts
- Forward Rate Agreements (FRA)
- Credit Risk and Forward Contracts
- Introduction to Futures Contracts
- Futures: Convergence of Spot and Futures Prices at Expiration
- Futures Prices vs. Forward Prices
- Contago and Backwardation
- Pricing Stock Index Futures
- Pricing Interest Rate/Treasury Bond Futures
- Pricing Currency Futures
- Eurodollar Futures
Currency Forward Contracts
- A currency forward contract involves two currencies and two interest rates. A currency forward contract lets you lock-in a pre-defined price at which you can buy/sell a currency on a future date.
- Contract parties commonly enter into currency forwards with the objective of hedging exchange rate risk exposure.
- The interest rates can be interpreted as a net cash flow yield of investing one currency in a risk free asset and borrowing the other currency.
Price of a Currency Forward with Simple Compounding:
F(0,T)X/Y = S0,X/Y × ((1+rX)/(1+rY))T
Where:
- S0 = Spot exchange rate for X/Y (#X units domestic per 1Y foreign) at initiation
- rX = Risk free rate in country X (domestic currency)
- rY = Risk free rate in country Y (foreign currency)
Price of a Currency Forward with Continuous Compounding
F(0,T)X/Y = (S0,X/Y e-ryT ) erxT
Value of a Currency Forward with Simple Compounding
Vt(0,T)X/Y = (St,X/Y / (1+rY)(T-t)) - (F(0,T)X/Y / (1+rX)(T-t))
Value of a Currency Forward with Continuous Compounding
Vt(0,T)X/Y = (St,X/Y e-ry(T-t)) - (F(0,T)X/Y e-rx(T-t))
You may find these interesting
Cross Rates and Different Base CurrenciesIf we look at two sets of currency pairs with different base currencies you can still adopt the same...
Currency Devaluations – A Forex Trader’s GuideIn the past few years we have seen many currency devaluations, for example Thai government devaluing...
Introduction to Forward Rate AgreementsForward Rate Agreements (FRA’s) are similar to over-the-counter futures contracts (but there is no m...
Dodd Frank Act - Title XVI: Section 1256 Contracts**Certain swaps, etc., not treated as section 1256 contracts.**
The term ‘section 1256 contract’ sh...
What are Foreign Currency Swaps?Currency swaps are foreign exchange contracts in which two parties agree to exchange the principal a...
Settlement of Futures ContractsWhen a futures trader takes a position (long or short) in a futures contract, he can settle the cont...
Trading Futures Contracts: How Does it Work?In this article, we will discuss in detail about how futures contracts are traded.
The futures cont...
Overview of Currency Markets- **[Spot market](https://financetrain.com/understanding-spot-fx-transactions/ "Understanding Spot...
Forward Exchange Rates Forward contracts commonly trade at premiums or discounts to the [spot rate](https://financetrain.co...
Finance Train Premium
Accelerate your finance career with cutting-edge data skills.
Join Finance Train Premium for unlimited access to a growing library of ebooks, projects and code examples covering financial modeling, data analysis, data science, machine learning, algorithmic trading strategies, and more applied to real-world finance scenarios.
I WANT TO JOINJOIN 30,000 DATA PROFESSIONALS
Free Guides - Getting Started with R and Python
Enter your name and email address below and we will email you the guides for R programming and Python.