Tutorial: Computing Implied Foreign Interest Rates from Currency Forwards

Tutorial: Computing Implied Foreign Interest Rates from Currency Forwards

The financial press such as the Wall Street Journal publish freely US rates but do not publish the rates for other countries. Internet provides a richer source of information. However, in this first exercise will apply Option Tutor to inferring LIBOR rates for other countries from data published in the financial press. If you access to a better data source then you are encouraged to compare the results from this current Tutor Break with your own data source.

Problem: What are the implied 30-, 90- and 180-day LIBOR rates for Germany?

Step 1: Click on the Option Calculator subject in Option Tutor. From the menu items click on Options and then both sub menu items Calculator and Futures Calculator.

Data: For the close of markets November 29, 1996 the following relevant data is obtained from the Wall Street Journal.

Germany (Mark)

Spot Rate: 0.6499

30-Day Forward 0.6511

90-Day Forward 0.6535

180-Day Forward 0.6572

Money Rates: Late London LIBOR

1-Month 5 1/2%

3-Month 5 7/16%

6-Month 5 15/32%

Step 2: Select LIBOR in the Calculator, enter the 1-Month rate, click on Convert and then Transfer. In addition, enter 1-month into the Convert Days into Maturity section, click on Convert and then Transfer. We will assume that the day count is 30 days for the LIBOR deposit.

This transfers the domestic LIBOR rate and the time to maturity to the Futures calculator.

Step 3: In the futures calculator first select currency for the underlying. Enter the spot Mark exchange rate and the 30-Day Forward price. Select implied Foreign Rate and click on Calculate. The implied 30-day LIBOR rate (continuously compounded) for Germany is 0.0332.

Step 4: Repeat the process for the 90-Day rate. The implied rate is 0.0326:

Step 5: Repeat the process for the 180-Day rate. The implied rate is 0.0322:

Having spot LIBOR rates is useful for a range of exercises including Yield Curve building from Eurodollar Futures markets.

Tutor Hint: Of course it does not matter which currency you are working with. However, care should be taken to keep definitions consistent. For example, if you are working the above exercise in Deutschmarks then you need to use the spot currency in terms of Marks per $1 USD. The Foreign rate is US LIBOR and you are solving for the Implied (Domestic) rate.