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# SCHEDULE I: Instruments for the Management of Foreign-Exchange Exposure

## Spot Foreign-Exchange Contract

• An exchange rate is the value of one currency expressed in terms of another currency.

• The spot value refers to the exchange rate where settlement will be made not more than two business days from the contract date (today).

### Quoting Spots

• An example of a spot quote is NZD / USD 0.5650.

• This means that 1 NZD = 0.5650 USD.

## Forward Foreign-Exchange Contract

• A forward exchange rate (FWD) is a rate agreed today at which one currency is sold/bought against another for delivery on a specified future date.

### Calculating Forwards

• The forward price of a currency is not a forecast of where the value of that currency will be, or is expected to be, at a given future date.
• Instead, it is a reflection of interest-rate differentials between countries/ currencies.

Example:

A hypothetical example of the calculation of a forward exchange rate follows:

Assumptions -

• US \$600,000 payment to be made in six months’ time
• Spot exchange rate is NZ \$1 = US \$0.55
• NZ interest rate is 6% per annum
• US interest rate is 1.5% per annum

The forward rate would be calculated as follows:

Suppose a department needs to pay US \$600,000 for computer equipment in six months’ time. The department has two options:

1. It can borrow NZ \$1,082,758.88 now and sell that amount now at the spot rate of 0.55 to buy US \$595,533.50. The USD can then be invested at 1.5% for six months to give US \$600,000 on the payment date. The company would then have to pay back NZ \$1,115,241.65 (NZ \$1,082,758.88 borrowed @ 6% for six months); or

2. The department can transact now at a FX forward rate of 0.538 to sell NZ \$1,115,241.65 to buy US \$600,000 in six months time.

The economics of both options are the same. The benefit of option 2 is that it is a simpler solution because there are fewer transactions involved.

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