Regarding forecasting exchange rate movements according to my notes I have got the following two formulas:
- Inflation: S1 = S0 x (1+hc / 1+hb)
Where hc = inflation in country overseas
hb = base country inflation
- Interest: F0 = S0 x (1+ic / 1+ib)
Where c = interest in country overseas
b = base country interest
However, according to the answers in my revision kit they are the other way round. Could you kindly tell me which one is correct please?
What you have written is correct, provided you are defining the ‘base’ county correctly.
If for example the exchange rate is quoted in $’s per £, then the ‘base’ country is the UK.
If the exchange rate is quotes as Euros per $, then the ‘base’ country is the US.
Ok, thank you that was helpful. Also does ‘h’ refer to inflation and ‘i’ to interest please as I always seem to get that confused?
Yes – h is inflation and i is interest
(but it is the same formula so it doesn’t really matter too much )
Thanks a lot really helpful
You are welcome
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