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Handria is a country that has pero for its currency & Wengry is a country that has dollar for its currency.
The current spot rate exchange rate is 1.5134 peso = $1
Using interest-rate differentials, the one year forward exchange rate is 1.5346 peso = $1
The currency market between peso & the dollar is assumed perfect & international fisher effect holds.
Which of the following is true?
a) Wengry has a higher forecast rate of inflation than Handria
b) Handria has a higher nominal rate of interest than Wengry
c) Handria has a higher real rate of interest than Wengry
d) The forecast future spot rate of exchange will differ from forward exchange rate
I don’t know how to answer this question sir. I have cancel the two options C & D since they are not true BUT confused with the options given such as A & B. Can you pls clear this problem to me?
Using the IRP formula, for the forward rate to be higher, the actual/nominal interest rate in Handria (the peso country) will be higher than that for Wengry (the $ country). Therefore B is correct.
In theory, interest rates go up and down with inflation rates, and therefore if the interest rate in Handria is higher, then so too the inflation rate should also be higher. Therefore A is not correct.
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