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Question 21.3: Looking Forward Suppose you are expecting to receive a mill...

Looking Forward

Suppose you are expecting to receive a million British pounds in six months, and you agree to a forward trade to exchange your pounds for dollars. Based on Figure 21.1 , how many dollars will you get in six months? Is the pound selling at a discount or a premium relative to the dollar?

21.1
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In Figure 21.1 , the spot exchange rate and the 180-day forward rate in terms of dollars per pound are $1.5861 = £1 and $1.5832 = £1, respectively. If you expect £1 million in 180 days, you will get £1 million × $1.5832 per pound = $1.5832 million. Because it is less expensive to buy a pound in the forward market than in the spot market ($1.5832 versus $1.5861), the pound is said to be selling at a discount relative to the dollar.

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