Chapter 5
Using Forwards for
International Financial
Management
In this chapter, we discuss the five main purposes for which forward contracts are
used: arbitrage (or potential arbitrage), hedging, speculation, shopping around, and
valuation. These provide the topics of Sections 5.2 to 5.6, respectively. But first
we need to spend some time on practical issues: the quotation method, and the
provisions for default risk (Section 5.1).
5.1 Practical Aspects of Forwards in Real-world Markets
kets
5.1.1 Quoting Forward Rates with Bid-Ask Spreads
With bid-ask spreads, a forward rate can still be quoted “outright” (that is, as an
absolute number), or as a swap rate. The outright quotes look like spot quotes
in that they immediately give us the level of the forward bid and ask rates; for
instance, the rates may becad/usd(180 days) 1.1875–1.1895. Swap rates, on the
other hand, show the numbers that are to be added to/subtracted from the spot
bid and ask rates in order to obtain the forward quotes. One ought to be careful
in interpreting such quotes, and make sure that the correct number is added to or
subtracted from the spot bid or ask rate.
Example 5.1
Most papers nowadays show outright rates, but Antwerp’sDe Tijdused to publish
swap rates until late 2005. Table 5.1 shows an example, to which I added a column
of midpoint swap rates andLIBOR30d interest rates (simple, p.a.). Swap rates are