summer 2018 exam 21 Protecte to this PC ilings Review View A

summer 2018 exam 21 Protecte to this PC ilings Review View Add-ins Parity conditions Spot exchange rate Inflation 1-year Country USD/foreign currency) rate itrt rate 111.02 10589 5803.0 700% Nepal USD NPR Botswana USD/BWP Paraguay USD/PYG 3.20% 5.25% 2.75 % | 4.10% 12.50% United States la. Forecast the expected exchange rate in six months for the Botswanan pula b. What parity condition does this rely on? 2a. Forecast the expected exchange rate in nine months for the Nepalese rupee. b what parity condition does this rely on?

Solution

Below are the answers. Feel free to reach out in case of any doubts/clarifications.

1.a. According to the covered Interest Rate parity,

Forward rate (A/B) = (1 + (Interest rate of A * days/360)) / ( 1 + (Interest rate of B * days/360)) * Spot Rate (A/B)

Thus, Forward Rate for Botswana Pula = ( 1 + 3.2% *0.5)/(1 + 2.75%*0.5) * 10.589

= ( 1+ 1.6%)/(1+ 1.375%) * 10.589 = 10.6125 = ~10.613

1. b. This relies on the fact that uncovered interest rate parity should also hold which states that forward rate is an unbiased predictor of the future spot rate.

Thus, both forms of interest rate parity should hold

2. a. According to the Relative Purchasing Power parity

t= 9 months = 9/12 = 0.75

S_t (A/B) = S₀ * ((1+ inflation_A) / (1+ inflation_B))^t

Thus, S_t = 111.02 * ( (1 + 0.07)/(1 + 0.025))^0.75

St = 114.6558 = ~114.66

This relies on Relative Purchasing Power parity

Another way to solve this is by % change in spot rate = inflation A - inflation B = 7% - 2.5% = 4.5%

Thus, St = 111.02 * ( 1+0.045) = 116.02

3.a. and b. PYG

1-year forward rate - relies on Covered interest rate parity

Forward rate = 5803.0 * ( 1+ 5.25%* 360/360)/(1+ 2.75%*360/360)

= 5803.0 * (1.0525)/(1.0275) = 5944.2