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There is an Mcq that
The home country of ACB co is dollar ($) and it trades with a company in foreign country whose home currency is Dinar. The following info is available
Home country Foreign country
Spot rate 20 Dinar per $
Interest rate 3% per year 7% per year
Inflation rate 2% per year 5% per yearWhat is 6 month forward exchange contract
When using interest rate parity theory the answer is coming 20.39 dinar per $, however, when purchasing power parity theory answer is coming 20.30 dinar per $. However correct ans is 20.39. Can you please explain me why we have to use IRPT here instead of PPPT?
If you watch my free lectures then you will see that purchasing power parity is used to forecast future spot rates, whereas interest rate parity is used to calculate forward rates (which is obviously not the same thing, and is the case in this question).
The lectures are a complete free course for Paper FM and cover everything needed to to be able to pass the exam well.)
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