02 January 2008
Dear Sir, Can you please explain me whether the theory of adding the swap points to the spot rate to obtain the forward rate when the swap points are in increasing trend and deducting the swap points from the spot rate to find out the forward rate when the swap points are in decreasing trend is always true or are there any exceptions. i mean if only swap basis points are available and spot rates(buy/offer rate) are available then we can find out the forward rate by adding or deducting the swap points to the spot rates in case of increasing or decreasing trends respectively. let us take an example: suppose the spot rate is 1US$ = Rs. 40/42 and the int. rate in India is 10% and in USA it is 8%, then as per IRP theorem, the forward rate shall be computed as Rs. 40.74/42.78, this means swap points are 74/78 (increasing trend), so here we will add this to spot rate rs. 40/42 to get 40.74/42.78. Now let us change the exchange rate, in India the int. rate is 8% and in USA the int. rate is 10%, now as per IRP Theorem the forward rate shall be rs. 39.27/41.24, here the swap points are 74/76 (again increasing trend) but now we can't add this to the spot rate to get the forward rate. So how can we say that the swap points are to be added/deducted to the spot rates in case of increasing trend / decreasing trend. if the above theory is correct then plz. explain how we can identify whether to add or deduct the points to the spot rates in case only the swap points and the spot rates are given. i am really confused. Awaiting your reply asap.
CAclubindia
