forward market intervention can influence the spot exchange rate as well.<sup>2</sup> But in contrast to spot market interventions, forward market interventions do not require immediate funding because payment takes place when the transaction is completed at a future date with the purchase or the sale of the foreign exchange. Forward market intervention can thus be conducted discretely, with little impact on FX reserves, as long as the factor that triggers the intervention is short-lived. Influencing the spot exchange rate without affecting the level of FX reserves is also a feature of the strategic approach to intervention outlined in this paper (Section 4), although the mechanism is very different from forward market intervention. The Bank of Thailand used forward market sales of FX to prop up the currency early in the East Asian financial crisis. The Reserve Bank of South Africa and the Reserve Bank of India have on occasions resorted to forward market FX intervention, along with other central banks.<sup>3</sup> FX options have also been used tactically by some central banks (Mexico, Colombia, Chile), mainly with the aim of accumulating FX reserves with minimum disruption in the spot FX market (see below).

Most central banks exercise discretion in determining when and in what amount to intervene, usually releasing actual transaction data with a lag (if at all). Discretion allows central banks to evaluate market conditions and keep room for tactical maneuvering. It is commonly argued that although intervention rules may be useful as rules of thumb, discretion may be preferable as rules might be unnecessary in the presence of other nominal anchors (such as inflation targeting). It is sometimes argued that market participants can possibly take advantage of intervention rules to speculate against the central bank (Shogo et al, 2006).

However, some central banks also use forms of rules-based intervention:

> 2 Covered interest parity can be illustrated by considering the options open, for example, to an investor who can hold either a US$ or a euro-denominated asset for one year. Holding the US$-denominated asset yields a return of 1+ _R$_ per US$ (where _R$_ is the interest rate on the US$ asset). Investing an equal amount of US$ into euro-denominated assets, at the spot exchange rate of _S_ euros per US$, would yield a return of (1+ _Re_ )• _S_ in euros per dollar invested. If the investor contracts to convert the proceeds back into US$ in one year at the prevailing euro-per-dollar forward exchange rate _F_ at the beginning of the investment period, the expected return per dollar would be (1+ _Re_ )•( _S/F)_ . Covered interest parity (CIP) establishes no-arbitrage (equality) between the returns under the two strategies: 1+ _R$ =_ (1+ _Re_ )•( _S/F)._ If CIP holds, FX intervention that changes the forward market exchange rate should also be reflected into a proportional change in the spot exchange rate.

> 3 According to a central bank survey reported in C.J. Neely (2000), 52.9 percent of 17 responding central banks were sometimes intervening in the forward FX market. This percentage was lower in the survey reported by BIS (see Archer, 2005).

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