1. If the spot rate for the Swiss Franc is that 1.15 SF is equal to1 US $, and the annual interest rate on fixed rate one-year deposits of SF is 1.5% and for US$ is 2.5%, what is nine-month forward rate for one dollarin terms of SFs? Assuming the same interest rates, what is the 18-month forward rate for one SF in US$s? Is this an indirect or a direct rate? If the forward rate is an accurate predictor of exchange rates, in this case will the SFget stronger or weaker against the dollar? What does this indicate about the market's inflation expectations forSwitzerland ascompared to the US?

Nine-month forward rate for one dollar in terms of SFs is 1.142

Thus, 18-month forward rate for one SF in US$s is 0.8824

This is an indirect rate

The SF will get stronger against the dollar

Its indicates that market's inflation expectations for Switzerland is lower than the inflation expectations for the US

Explanation:

Forward rate = S*[ (1+Rd) / (1+Rf) ]

Where S is spot rate, Rd is domestic interest rate, Rf is foreign interest rate.

The forward rate is the expected exchange rate between two currencies at some future date.

From the question, we see that S is 1.15 SF per dollar; Rd is 1.5%; Rf is 2.5%.

The nine-month forward rate for one dollar in terms of SFs is

= 1.15*[ (1+1.5%*9/12) / (1+2.5%*9/12) ]

Note that since the interest rate is annual we have to convert it to 9months interest rate.

=1.15 * (1.01125) / (1.01875)

=1.15*0.99264

=1.142

Thus, nine-month forward rate for one dollar in terms of SFs is 1.142

18-month forward rate for one SF in US$s = 1.15*[ (1+1.5%*18/12) / (1+2.5%*18/12) ]

Note that since the interest rate is annual we have to convert it to 18months interest rate.

=1.15 * (1.0225) / (1.0375)

=1.15*0.9855

=1.133

Thus, 18-month forward rate for one dollar in SF is 1.133

To find 18-month forward rate for one SF in US$s we divide 1 by 1.133

=1/1.133

=0.8824

Thus, 18-month forward rate for one SF in US$s is 0.8824

This is an indirect rate because we are quoting the domestic currency in terms of foreign currency. We are saying that 18 months from today 1 SF will buy $0.8824. Direct exchange rate is when the we state rate as the home currency price of one unit of foreign currency.

If the forward rate is an accurate predictor of exchange rates, the SF will get stronger against the dollar. This is because $1 was equivalent to 1.15 SF but after 18 month $1 will be exchange for 1.133. This means SF will be stronger.

With a stronger currency in Switzerland in 18-months, its indicates that market's inflation expectations for Switzerland is lower than the inflation expectations for the US. This is because the SF is expected to have a higher purchasing power compared to the US.