Contents Introduction Chapter I. Theoretical foundations of currency regulation

F – forward exchange rate in terms of unit of domesic currency per unit of foreign currency;
S – spot exchange, in terms of units of domestic currency per unit of foreign currency;
I_d – domestic inflation rate;
I_f – for5eign inflation rate;
n – number of time periods.

F= S×		1 + id		n
		1 + if

Using the covered interest rate parity, forward exchange rate is calculated using the following formula:

F, S and n stand for the same as stated above;

I_d - domestic interest rate;
I_f – foreign interest rate.
Example:
“Exchange rate between US $ and British £ on 1 January 2012 was $1.55 per £. This is our spot exchange rate. Inflation rate and interest rate in US were 2.1% and 3.5% respectively. Inflation rate and interest rate in UK were 2.8% and 3.3%.”⁹
Estimate the forward exchange rate between the countries in $/£.
Solution:
Using relative purchasing power parity, forward exchange rate comes out to be $1.554/£

f = $1.55/£ ×		1 + 3.5%		n	= $1.554/£
		1 + 3.3%

Using the interest rate parity, forward exchange rate is

f = $1.55/£ ×		1 + 2.1%		n	= $1.5401/£
		1 + 2.8%

Option Transaction: Foreign exchange option transaction refers to the buying and selling of a right. After paying a certain amount of option fees, the buyer has a right to exchange a particular currency at the agreed rate on a pre-determined settlement date in the future. In the mean time, the seller of right is also entitled to refuse to perform the above-mentioned transaction contract.
Features:
1. If the payment for goods prescribed in the corporate import and export trade contract takes place on one day in the future, it's always expected to avoid the losses due to foreign exchange rate fluctuation on one hand, and to gain the benefits brought by foreign exchange rate fluctuation on the other hand. After paying a certain amount of option fees, customers shall have the right to buy an agreed amount of currency from the bank and sell another type of currency in accordance with the contracted foreign exchange rate at the specific time in the future, or to gain the earnings of option fees by putting the option on the trading date.
2. The buyer of foreign exchange option can choose a beneficial foreign exchange rate from the contracted exchange rate and the spot exchange rate upon maturity to conduct settlement, and the seller of foreign exchange option can gain the income from option fees at the beginning of the transaction. Bank of China can provide customers with option portfolio and "zero option fees" product to avoid foreign exchange rate risk, and also provide portfolio of options with different terms to meet customers' demands for term matching.