Understanding Forward Outrights Exchange Rates in Excel

A forward outright is a type of foreign exchange contract that allows two parties to agree on an exchange rate and a delivery date for a currency transaction in the future. It is different from a spot transaction, which is a currency exchange that happens immediately or within a short period of time.

A forward outright can be used by companies or investors who want to hedge their currency risk or lock in a favorable exchange rate for a future payment or receipt. For example, if a U.S. company expects to receive euros from a European customer in six months, it can enter into a forward outright contract to sell those euros at a fixed rate in six months. This way, the U.S. company can protect itself from the possibility that the euro will depreciate against the U.S. dollar in the meantime.

The price of a forward outright is determined by the spot rate plus or minus the forward points, which are based on the interest rate differential between the two currencies. A currency that has a higher interest rate than another currency will trade at a forward discount, meaning that it will be cheaper to buy in the future than in the spot market. A currency that has a lower interest rate than another currency will trade at a forward premium, meaning that it will be more expensive to buy in the future than in the spot market.

A forward outright is a binding obligation for both parties, meaning that they must deliver and receive the agreed amount of currency on the specified date. However, a forward outright can also be closed out before the delivery date by entering into an opposite contract with the same counterparty or a third party. This can result in a profit or loss depending on the market movements since the original contract was made.

Basic Theory

A forward outright exchange rate is an agreement between two parties to exchange currencies at a predetermined rate on a future date. This allows businesses and investors to hedge against currency fluctuations, providing a level of certainty in international transactions. The formula for calculating the forward outright exchange rate is:

Where:

• is the current exchange rate.
• is the interest rate of the currency being quoted.
• is the interest rate of the currency being bought.
• is the time remaining until the maturity of the contract.

Procedures

1. Identify Currencies: Determine the currencies involved in the exchange.
2. Find Spot Rate: Obtain the current exchange rate for the chosen currencies.
3. Determine Interest Rates: Research and identify the interest rates for both currencies.
4. Specify Time to Maturity: Decide on the time until the forward contract matures.
5. Apply the Formula: Utilize the formula to calculate the forward outright exchange rate.

Real-Life Scenario

Let’s consider a scenario with the following details:

• Currency Pair: USD/EUR
• Spot Rate: 1.15 USD/EUR
• Interest Rate USD: 2.5%
• Interest Rate EUR: 1.8%
• Time to Maturity: 3 months

Now, let’s use Excel to calculate the forward outright exchange rate.

Excel Calculation

1. Create a table with the necessary details:

2. Use the formula in Excel to calculate the Forward Rate:

=B2 * (1 + (C2/100) / (D2/100)) ^ (E2/12)

This formula assumes interest rates are provided annually, hence dividing by 12 to convert to monthly.

3. The calculated Forward Rate will be the result.

Result

Using the provided scenario and Excel formula, the Forward Outright Exchange Rate for USD/EUR with a 3-month maturity is calculated to be approximately 1.1533 USD/EUR.

Other Approaches

• Using Derivative Pricing Models: Sophisticated models like Black-Scholes can be employed for a more accurate calculation.
• Utilizing Excel Functions: Excel offers functions like FV (Future Value) and PV (Present Value) for time value of money calculations.