Final answer:
The outright bids and asks for Swiss francs against the US dollar are calculated by adding the forward points to the spot rates, and the spread between these quotes increases for longer forward dates due to larger uncertainties. The exchange rate market reacts to interest rates, causing shifts in demand and supply and leading to new equilibriums with different exchange rates.
Step-by-step explanation:
The student is asking for the calculation of outright quotes for the bid and ask rates for Swiss francs relative to the US dollar, and for an analysis of the changes in the number of points spread between each as the quotes extend from spot to 6 months forward in the context of foreign exchange markets. The outright bid and ask quotes are derived by adding the forward points to the spot bid and ask rates, respectively. The number of points spread is the difference between the outright ask and bid quotes.
To calculate the outright quotes:
- Bid rate for 1 month forward = Spot bid + 1-month forward bid points = 1.2573 + 0.0010 = 1.2583
- Ask rate for 1 month forward = Spot ask + 1-month forward ask points = 1.2599 + 0.0015 = 1.2614
And so on for the 3-month and 6-month forward rates. The spread between outright bid and ask quotes increases as the term of the quote goes from spot to 6 months. The spread, which is the difference between the ask and bid quote, tends to widen as the quotes extend from spot to forward dates. This occurs as a result of the increasing uncertainty and risk over longer time periods, which market makers compensate for by charging a higher spread.
As the exchange rate market for US dollars reacts to higher interest rates, like in the U.S. T-Bill rate example, the demand for dollars in the foreign exchange market shifts resulting in an appreciation of the exchange rate. When international financial investors demand more US dollars to purchase government bonds, the equilibrium in the foreign exchange market changes, leading to an appreciated exchange rate. This is demonstrated by the shift in demand from Do to D₁ and the supply from So to S₁, arriving at a new equilibrium exchange rate that is stronger than the original.