Forecasting exchange rate movements

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    atab
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    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?


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    John Moffat
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    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.


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    atab
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    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?


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    John Moffat
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    Yes – h is inflation and i is interest :-)
    (but it is the same formula so it doesn’t really matter too much :-) )


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    atab
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    Thanks a lot really helpful :)


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    John Moffat
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    You are welcome :-)

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